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CHAPTER 12 CAPITAL BUDGETING: DECISION CRITERIA (Difficulty: E = Easy, M = Medium, and T = Tough) True-False Easy: Capital budget Answer: b Diff: E 1. A firm should never undertake an investment if accepting the project would cause an increase in the firm's cost of capital . a. True b . False PV of cash flows Answer: b Diff: E 2. Because present value refers to the value of cash flows that occur at different points in time, present values cannot be added to determine the value of a capital budgeting project . a. True b . False Ranking methods Answer: b Diff: E 3. Given two mutually exclusive projects and a zero cost of capital , the payback method and NPV method of selecting investments will always lead to the same decision on which project to undertake. a. True b . False Payback period Answer: a Diff: E 4. One advantage of the payback period method of evaluating fixed asset investment possibilities is that it provides a rough measure of a project's liquidity and risk. a. True b . False NPV 5. Answer: Assuming that the total cash flows are equal, the NPV of whose cash flows accrue relatively rapidly is more sensitive in the discount rate than is the NPV of a project whose cash in more slowly. a. True b . False b Diff: E a project to changes flows come Chapter 12 - Page 1 IRR 6. Answer: a Diff: E The internal rate of return is that discount rate which equates the present value of the cash outflows (or costs) with the present value of the cash inflows. a. True b . False IRR 7. Answer: a Diff: E Under certain conditions, a particular project may have more than one IRR . One condition under which this situation can occur is if , in addition to the initial investment at time = 0, a negative cash flow occurs at the end of the project's life. a. True b . False IRR 8. Answer: b Diff: E Other things held constant, an increase in the cost of capital discount rate will result in a decrease in a project's IRR . a. True b . False IRR and NPV Answer: b Diff: E 9. If a project's NPV exceeds the project's IRR , then the project should be accepted. a. True b . False Multiple IRRs Answer: b Diff: E 10. The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects which have different lives are being compared. a. True b . False Modified IRR Answer: b Diff: E 11. The modified IRR (MIRR) method has wide appeal to professors, but most business executives prefer the NPV method to either the regular or modified IRR . a. True b . False Modified IRR Answer: b Diff: E 12. The modified IRR (MIRR) always leads to the same capital budgeting decisions as the NPV method. a. True b . False Chapter 12 - Page 2 Mutually exclusive projects Answer: a Diff: E 13. Conflicts between two mutually exclusive projects, where the NPV method chooses one project but the IRR method chooses the other,
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should generally be resolved in favor of the project with the higher NPV . a. True b . False Reinvestment rate assumption Answer: a Diff: E 14. The
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This note was uploaded on 07/18/2011 for the course FI 515 taught by Professor Watson during the Spring '09 term at Keller Graduate School of Management.

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