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Some Practice Question in Capital Budgeting

This document contains 6 practice questions related to capital budgeting. Question 1 asks which project has cash flows occurring earlier based on two NPV profiles. Question 2 asks which project's NPV is more sensitive to changes in the WACC based on cash flow information. Question 3 provides cash flows for a project and asks to calculate payback period, IRR, and NPV. Question 4 asks for the crossover rate where two projects' NPVs are equal. Question 5 provides cash flows and asks to calculate a project's MIRR. Question 6 provides cash flows for two projects and asks several questions related to payback period, discounted payback period, NPV, and project selection based on different discount rates.

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267 views3 pages

Some Practice Question in Capital Budgeting

This document contains 6 practice questions related to capital budgeting. Question 1 asks which project has cash flows occurring earlier based on two NPV profiles. Question 2 asks which project's NPV is more sensitive to changes in the WACC based on cash flow information. Question 3 provides cash flows for a project and asks to calculate payback period, IRR, and NPV. Question 4 asks for the crossover rate where two projects' NPVs are equal. Question 5 provides cash flows and asks to calculate a project's MIRR. Question 6 provides cash flows for two projects and asks several questions related to payback period, discounted payback period, NPV, and project selection based on different discount rates.

Uploaded by

SHanim
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Some Practice question in Capital Budgeting.

(Past final exam questions)


1. Projects A and B have identical expected lives and identical initial cash outflows (costs).
However, most of one project’s cash flows come in the early years, while most of the other
project’s cash flows occur in the later years. The two NPV profiles are given below:

NPV
($)

r (%)

Which of the following statements is CORRECT and WHY?


A. More of Project A’s cash flows occur in the later years.
B. More of Project B’s cash flows occur in the later years.
C. We must have information on the cost of capital in order to determine which project has
the larger early cash flows.
D. The NPV profile graph is inconsistent with the statement made in the problem.
E. The crossover rate, i.e., the rate at which Projects A and B have the same NPV, is greater
than either project’s IRR.

2. Projects S and L both have an initial cost of Rs. 10,000, followed by a series of positive cash
inflows. Project S’s undiscounted net cash flows total to Rs. 20,000, while L’s total undiscounted
flows are Rs. 30,000. At a WACC of 10%, the two projects have identical NPVs. Which
project’s NPV is more sensitive to changes in the WACC? (Hint: it is recommended to draw a
NPV profile)
A. Project S.
B. Project L.
C. Both projects are equally sensitive to changes in the WACC since their NPVs are equal at
all costs of capital.
D. Neither project is sensitive to changes in the discount rate, since both have NPV profiles
that are horizontal.
E. The solution cannot be determined because the problem gives us no information that can
be used to determine the projects’ relative IRRs.
3. Van Auken Inc. is considering a project that has the following cash flows:
Year Cash Flow
0 -Rs 1,000
1 400
2 300
3 500
4 400

The company’s WACC is 10%. What are the project’s payback, internal rate of return, and net
present value? ( Ans. Payback = 2.6, IRR = 21.22%, NPV = Rs.260.)

4. ZumBahlen Inc. is considering the following mutually exclusive projects:


Project A Project B
Year Cash Flow Cash Flow
0 -Rs. 5,000 -Rs.5,000
1 200 3,000
2 800 3,000
3 3,000 800
4 5,000 200

At what cost of capital will the net present value of the two projects be the same? (That is, what is
the “crossover” rate?) (Ans 16.15%)
What is the implication and rationale of cross over rate?
5. Edelman Electric Systems is considering a project that has the following cash flow and WACC
data. What is the project's MIRR? Note that a project's projected MIRR can be less than the
WACC (and even negative), in which case it will be rejected. (Ans 13.14%)

WACC: 10.00%
Year: 0 1 2 3
Cash flows: - Rs. 800 $350 $350 $350
6. For the question given below , use the following cash flows for projects A and B:
A: (- Rs. 2000, Rs. 500, Rs. 600, Rs. 700, Rs. 800) B: (-Rs 2000, 950, 850, 400, 300)
a) Calculate the payback period for projects A and B. [Ans: 3.25 yrs and 2.5 yrs]
b) If the discount rate is 12%, what is the discounted payback period for project A? For B? [
Ans: A doesn’t payback, For B it is 4 yrs]
c) If A and B are mutually exclusive and the required rate of return is 5%, which should be
accepted? [Ans: NPV(A)=283.26, (B)= 268.08, So A is preferred even though it has the
lower IRR]
d) If the discount rate is 12%, and A and B are mutually exclusive, which project should be
accepted? [Ans: (-68.59), 1.20, B is preferred]

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