Jenna Kiragis

5/18/2014
FIN 534 Homework Chapter 10


Directions: Answer the following five questions on a separate document. Explain how you
reached the answer or show your work if a mathematical calculation is needed, or both. Submit
your assignment using the assignment link in the course shell. Each question is worth five points
apiece for a total of 25 points for this homework assignment.


1. Which of the following statements is CORRECT?
a. The NPV profile graph for a normal project will generally have a positive (upward)
slope as the life of the project increases.
b. An NPV profile graph is designed to give decision makers an idea about how a
project's risk varies with its life.
c. An NPV profile graph is designed to give decision makers an idea about how a
project's contribution to the firm's value varies with the cost of capital.
d. We cannot draw a project's NPV profile unless we know the appropriate WACC
for use in evaluating the project's NPV.
e. An NPV profile graph shows how a project's payback varies as the cost of capital
changes.

Explanation:
The NPV is defined as the present value of a projects expected cash flows (including
initial cost) discounted at the appropriate risk-adjusted rate (Brigham & Ehrhardt, 2014).
Therefore the NPV profile graph is giving the decision makers an idea about how a
projects contribution with the fluctuations or variances with cash flow. That is why I
choose answer C.



2. Which of the following statement s is CORRECT? Assume that the project being considered
has normal cash flows, with one outflow followed by a series of inflows.
a. The higher the WACC used to calculate the NPV, the lower the calculated NPV
will be.
b. If a project's NPV is greater than zero, then its IRR must be less than the WACC.
c. If a project's NPV is greater than zero, then its IRR must be less than zero.
d. The NPVs of relatively risky projects should be found using relatively low
WACCs.
e. A project's NPV is generally found by compounding the cash inflows at the
WACC to find the terminal value (TV), then discounting the TV at the IRR to find
its PV.


Explanation:
From chapter 9 we learned that the Companys WACC (or Weighted Average Cost of
Capital) reflects the average risk of all the companys projects (Brigham & Ehrhardt,
2014). If the companys WACC is already high then, of course, then Net Present Value
(or NPV) is going to be low. Answer A fits this logic.



3. Which of the following statements is CORRECT? Assume that the project being considered
has normal cash flows, with one outflow followed by a series of inflows.
a. If Project A has a higher IRR than Project B, then Project A must also have a
higher NPV.
b. The IRR calculation implicitly assumes that all cash flows are reinvested at the
WACC.
c. The IRR calculation implicitly assumes that cash flows are withdrawn
from the business rather than being reinvested in the business.
d. If a project has normal cash flows and its IRR exceeds its WACC, then the
project's NPV must be positive.
e. If Project A has a higher IRR than Project B, then Project A must have the lower
NPV.


Explanation:
I choose answer D because in trail-and-error of testing the formulas given to us in the
previous chapters, when the IRR (Internal rate of return) exceeds the WACC, then I see
that the NPV of the project is positive.



4. Which of the following statements is CORRECT?
a. If two projects are mutually exclusive, then they are likely to have multiple IRRs.
b. If a project is independent, then it cannot have multiple IRRs.
c. Multiple IRRs can occur only if the signs of the cash flows change more than
once.
d. If a project has two IRRs, then the smaller one is the one that is most relevant,
and it should be accepted and relied upon.
e. For a project to have more than one IRR, then both IRRs must be greater than
the WACC.


Explanation:
From our textbook, we see MIRRs when there is nonnormal cash flows or cash flows that
change negative to positive and back (or --++++--). This is why I choose answer C.



5. Which of the following statements is CORRECT?
a. The NPV method assumes that cash flows will be reinvested at the risk-free rate,
while the IRR method assumes reinvestment at the IRR.
b. The NPV method assumes that cash flows will be reinvested at the WACC, while
the IRR method assumes reinvestment at the risk-free rate.
c. The NPV method does not consider all relevant cash flows, particularly cash
flows beyond the payback period.
d. The IRR method does not consider all relevant cash flows, particularly cash flows
beyond the payback period.
e. The NPV method assumes that cash flows will be reinvested at the WACC, while
the IRR method assumes reinvestment at the IRR.


Explanation:
The NPV method discounts all cash flows at the project's cost of capital (required rate of
return) and then sums those cash flows. Positive NPV projects add value to the firm and
increases shareholder's wealth money reinvested at the WACC. The internal rate of
return (IRR) is defined as the discount rate which forces a project's NPV to equal zero.
The IRR is the project's expected rate of return (same as a bond's yield to maturity)
money is reinvested at the IRR.

Brigham, E., & Ehrhardt, M. (2014). Financial management. (14th ed.). Mason, Ohio: Cengage Learning.