Westchester Corp. is considering two equally risky, mutually exclusive projects, both of which have normal cash flows.

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Question 13

  1. Westchester Corp. is considering two equally risky, mutually exclusive projects, both of which have normal cash flows.  Project A has an IRR of 11%, while Project B’s IRR is 14%.  When the WACC is 8%, the projects have the same NPV.  Given this information, which of the following statements is CORRECT?

    Answer

    If the WACC is 13%, Project A’s NPV will be higher than Project B’s.
    If the WACC is 9%, Project A’s NPV will be higher than Project B’s.
    If the WACC is 6%, Project B’s NPV will be higher than Project A’s.
    If the WACC is greater than 14%, Project A’s IRR will exceed Project B’s.
    If the WACC is 9%, Project B’s NPV will be higher than Project A’s.

2 points

Question 14

  1. Which of the following statements is CORRECT?

    Answer

    If a project has “normal” cash flows, then its IRR must be positive.
    If a project has “normal” cash flows, then its MIRR must be positive.
    If a project has “normal” cash flows, then it will have exactly two real IRRs.
    The definition of “normal” cash flows is that the cash flow stream has one or more negative cash flows followed by a stream of positive cash flows and then one negative cash flow at the end of the project’s life.
    If a project has “normal” cash flows, then it can have only one real IRR, whereas a project with “nonnormal” cash flows might have more than one real IRR.

2 points

Question 15

  1. Which of the following statements is CORRECT?

    Answer

    One advantage of the NPV over the IRR is that NPV takes account of cash flows over a project’s full life whereas IRR does not.
    One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested at the WACC, whereas IRR assumes that cash flows are reinvested at the IRR.  The NPV assumption is generally more appropriate.
    One advantage of the NPV over the MIRR method is that NPV takes account of cash flows over a project’s full life whereas MIRR does not.
    One advantage of the NPV over the MIRR method is that NPV discounts cash flows whereas the MIRR is based on undiscounted cash flows.
    Since cash flows under the IRR and MIRR are both discounted at the same rate (the WACC), these two methods always rank mutually exclusive projects in the same order.

2 points

Question 16

  1. Which of the following statements is CORRECT?

    Answer

    Using accelerated depreciation rather than straight line would normally have no effect on a project’s total projected cash flows but it would affect the timing of the cash flows and thus the NPV.
    Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.
    Corporations must use the same depreciation method (e.g., straight line or accelerated) for stockholder reporting and tax purposes.
    Since depreciation is not a cash expense, it has no effect on cash flows and thus no effect on capital budgeting decisions.
    Under accelerated depreciation, higher depreciation charges occur in the early years, and this reduces the early cash flows and thus lowers a project’s projected NPV.

2 points

Question 17

  1. Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?

    Answer

    The new project is expected to reduce sales of one of the company’s existing products by 5%.
    Since the firm’s director of capital budgeting spent some of her time last year to evaluate the new project, a portion of her salary for that year should be charged to the project’s initial cost.
    The company has spent and expensed $1 million on R&D associated with the new project.
    The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project.
    The firm would borrow all the money used to finance the new project, and the interest on this debt would be $1.5 million per year.

2 points

Question 18

  1. Which of the following statements is CORRECT?

    Answer

    If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its competitors.  Thus, cannibalization is dealt with by society through the antitrust laws.
    If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its customers.  Thus, cannibalization is dealt with by society through the antitrust laws.
    If cannibalization exists, then the cash flows associated with the project must be increased to offset these effects.  Otherwise, the calculated NPV will be biased downward.
    If cannibalization is determined to exist, then this means that the calculated NPV if cannibalization is considered will be higher than the NPV if this effect is not recognized.
    Cannibalization, as described in the text, is a type of externality that is not against the law, and any harm it causes is done to the firm itself.
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