Name Stadent ID I. Multiple Choices (45 points) 1. A major disadvantage of the p
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Name Stadent ID I. Multiple Choices (45 points) 1. A major disadvantage of the payback period is that it a. Is useless as a risk indicator. b. Ignores cash flows beyond the payback period. c. Does not directly account for the time value of money. d. Statements b and c are correct. e. All of the statements above are correct. 2. Project A has an internal rate of return (IRR) of 15 percent. Project B has an IRR of 14 percent. Both projects have a cost of capital of 12 percent. Which of the following statements is most correct? a. Both projects have a positive net present value (NPV) b. Project A must have a higher NPV than Project B. e. If the cost of capital were less than 12 percent, Project B would have a higher IRR than Project A. d. Statements a and c are correct. e. All of the statements above are correct. 3. Project X and Project Y each have normal cash flows (an up-front cost followed by a series of positive cash flows) and the same level of risk. Project X has an IRR equal to 12 percent, and Project Y has an IRR equal to 14 percent. If the WACC for both projects equals 9 percent, Project X has a higher net present value than Project Y. Which of the following statements is most correct? a. If the WACC equals 13 percent, Project X will have a negative NPV, while Project Y will have a positive NPV b. Project X probably has a quicker payback than Project Y c. The crossover rate in which the two projects have the same NPV is greater than 9 percent and less than 12 percent. d. Statements a and b are correct. e. Statements a and c are correct. 4. A company estimates that its weighted average cost of capital (WACC) is 10 percent. Which of the following independent projects should the company accept? a. Project A requires an up-front expenditure of $1,000,000 and generates a net present value of $3200. b. Project B has a modified internal rate of return of 9.5 percent. c. Project C requires an up-front expenditure of $1,000,000 and generates a positive intermal rate of return of 9.7 percent. d. Project D has an internal rate of return of 9.5 percent. e. None of the projects above should be accepted. S. The capital budgeting director of Sparrow Corporation is evaluating a project that costs $200,000, is expected to last for 10 years, and produces after-tax cash flows, including depreciation, of $44,503 per year. If the firm's cost of capital is 14 percent, what is the project's IRR? a. 8% b. 14% d.-5% 1896 12%Explanation / Answer
1. d. Statements b & c are corret.
Payback period considers only the cash flows that are able to recover the initial investment. This method does not evaluate the cash flows after the initial investment is recovered i.e. cash flows after the payback period. Also, payback period is calculated using absolute cash flows and ignores any discounting factor/ time value of money.
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