Question Details

Risk in a project which has only negative cash flows 



1. Project A and B both have normal cash flows. 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.
c.	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.	Statements a, b, and c are correct.

2. Which of the following statements is most correct?

a.	If a project with normal cash flows has an IRR which exceeds the cost of capital, then the project must have a positive NPV.
b.	If the IRR of Project A exceeds the IRR of Project B, then Project A must also have a higher NPV.
c.	The modified internal rate of return (MIRR) can never exceed the IRR.
d.	Answers a and c are correct.
e.	None of the answers above is correct.

3. Which of the following is not an incremental cash flow that results from the decision to accept a project?

a.	Changes in working capital.
b.	Shipping and installation costs.
c.	Sunk costs.
d.	Opportunity costs.
e.	Cannibalization of existing products.




4. Risk in a project which has only negative cash flows can best be adjusted for by

a.	Ignoring it.
b.	Adjusting the discount rate upward for increasing risk.
c.	Adjusting the discount rate downward for increasing risk.
d.	Picking a risk factor equal to the average discount rate.
e.	Reducing the NPV by 10 percent for risky projects.

5. Suppose the firm's WACC is stated in nominal terms, but the project's expected cash flows are expressed in real dollars.  In this situation, if prices are expected to increase, the calculated NPV would 

a.	Be correct.
b.	Be biased downward.
c.	Be biased upward.
d.	Possibly have a bias, but it could be upward or downward.
e.	More information is needed; otherwise, we can make no reasonable statement.



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