Topic —Capital Budget
MULTIPLE CHOICE
1. The most common technique for evaluating most capital investments is(are) a. payback period b. discount payback period c. internal rate of return d. net present value ANS:
2. Suppose a particular investment project will generate an immediate cash inflow of $1,000,000 followed by cash outflows of $500,000 in each of the next three years. The project’s IRR is 23% and the company uses a discount rate of 15%, compute the NPV for this project.
Should the company accept this project? a. No; reject the project b. Yes; accept the project c. IRR does not matter d. Insufficient information ANS:
The project has an initial cash inflow and subsequent cash outflows yielding a negative NPV, although its IRR is higher than the discount rate, the firm should reject the project.
3. A firm is evaluating two investment proposals. The following data is provided for the two investment alternatives.
Initial cash outflow IRR NPV Project 1 $250m 28% $80m Project 2 $ 50m 36% $20m
a. The discount rate for the two projects is 18%. If the two projects are independent, which project should the firm choose based on the IRR rule? a. project 1 b. project 2 c. both projects d. cannot decide because the hurdle rate is unknown ANS: C The discount rate represents the hurdle rate in the NPV computation which is 18%. Both projects pass the hurdle rate or are greater than the discount rate. b. If the two projects are mutually exclusive, using the IRR method which project should the firm accept? a. project 1 b. project 2 c. both projects d. cannot decide because the hurdle rate is unknown.