Project Evaluation: Master Net Present Value and Internal Rate of Return

Question 1

Based on the established decision rule, when is IRR used to accept a project?

Accepted Answer

IRR is greater than the discount rate

Answer

IRR is less than the discount rate

Answer

IRR is positive

Answer

IRR is negative

Question 2

Which of the following is NOT a limitation of IRR?

Accepted Answer

Provides a precise measure of profitability

Answer

Can have multiple IRRs

Answer

Assumes constant cash flows

Answer

Cannot handle projects with different lives

Question 3

The payback period of a project refers to:

Accepted Answer

The amount of time it takes for the cash inflows from a project to equal the initial investment

Answer

The amount of time it takes for the net present value (NPV) of a project to be zero

Answer

The amount of time it takes for the internal rate of return (IRR) of a project to be greater than the discount rate

Answer

The amount of time it takes for the annual cash flows of a project to be equal to the initial investment plus a desired rate of return

Question 4

Given a project with a positive Net Present Value (NPV) and an Internal Rate of Return (IRR) of 10%, what can you conclude?

Accepted Answer

The project is likely to generate a return higher than the cost of capital.

Answer

The project is not viable because the IRR is lower than the NPV.

Answer

The project should be rejected since the NPV is positive and the IRR is negative.

Answer

The project is acceptable but requires close monitoring as the IRR is near the cost of capital.

Question 5

NPV and IRR differ in that:

Accepted Answer

NPV measures absolute profitability while IRR measures rate of return

Answer

IRR measures absolute profitability while NPV measures rate of return

Answer

NPV is always more reliable than IRR

Answer

IRR is always more reliable than NPV

Question 6

How does a higher discount rate impact the NPV of a project?

Accepted Answer

Decreases the NPV

Answer

Increases the NPV

Answer

Has no effect on NPV

Answer

Only affects NPV if the project has positive cash flows

Question 7

What is the relationship between the IRR and the cost of capital?

Accepted Answer

IRR should exceed the cost of capital for a project to be viable

Answer

IRR should be less than the cost of capital for a project to be viable

Answer

IRR is independent of the cost of capital

Answer

IRR can only be used for projects with a positive cost of capital

Question 8

Define the Internal Rate of Return (IRR) of a project.

Accepted Answer

The discount rate that sets the NPV of a project to zero

Answer

The annual percentage return a project is projected to generate

Answer

The duration required for a project to recoup its investment

Answer

The maximum amount that can be invested in a project

Question 9

What does a higher IRR generally signify about a project?

Accepted Answer

Increased profitability

Answer

Longer payback period

Answer

Lower risk

Answer

Longer payback period

Question 10

Which of the following factors is most likely to result in a higher IRR?

Accepted Answer

A project with higher initial cash outflows but greater future cash inflows.

Answer

A project with lower initial cash outflows but smaller future cash inflows.

Answer

A project with a shorter payback period.

Question 11

Which of the following is an advantage of using the payback period?

Accepted Answer

It is straightforward to compute.

Answer

It enables comparison of projects with varying sizes.

Answer

It is not affected by variations in cash flow timing.

Answer

It takes into account the time value of money.

Question 12

A project's Net Present Value (NPV) will be negative if the present value of its future cash flows is __________ than the initial investment.

Accepted Answer

less

Answer

independent of

Answer

equal to

Answer

greater

Question 13

An investment requires an initial outlay of $10,000 and is expected to generate a single cash flow of $12,000 at the end of year 5. Assuming a discount rate of 10%, what is the Net Present Value (NPV) of this investment?

Accepted Answer

$1,557.91

Answer

$2,000

Answer

$1,000

Answer

$9,285.71

Question 14

A project has an Internal Rate of Return (IRR) of 12% and a Net Present Value (NPV) of $5,000. What does this indicate about the project's financial viability?

Accepted Answer

The project is financially viable and worth investing in.

Answer

The project is risky and should be rejected.

Answer

The project's profitability is uncertain, requiring further analysis.

Answer

The project is not profitable because IRR < NPV.

Question 15

Which of the following factors can directly influence the Internal Rate of Return (IRR) of a project?

Accepted Answer

Discount rate, cash flow pattern, initial investment

Answer

Exchange rate fluctuations only

Answer

Capital gains tax only

Answer

Inflation rate only

Question 16

Which of the following is a potential limitation of using Net Present Value (NPV) and Internal Rate of Return (IRR) for evaluating projects?

Accepted Answer

They assume a constant discount rate throughout the project's life.

Answer

They are only applicable to long-term projects.

Answer

They do not consider the timing of cash flows.

Answer

They are not widely accepted by financial institutions.

Question 17

In a mutually exclusive project analysis, which criterion is typically used to select the best project when comparing two or more alternatives?

Accepted Answer

The project with the highest NPV or IRR.

Answer

The project with the highest average annual return.

Answer

The project with the shortest payback period.

Answer

The project with the lowest initial investment.

Question 18

An investment opportunity has an IRR of 15% and a payback period of 4 years. In this case, which criterion should be prioritized for decision-making?

Accepted Answer

IRR, as it accounts for the time value of money.

Answer

Payback period, as it provides a quicker return on investment.

Answer

Both criteria are equally important.

Answer

Neither criterion should be used.

Question 19

What is the Net Present Value (NPV) of a project?

Accepted Answer

The present value of all future cash flows minus the initial investment

Answer

The total value of future cash flows at a specified interest rate

Answer

The difference between the project's cost and revenue

Question 20

Which of the following interpretations is valid if a project has a positive NPV?

Accepted Answer

The project is expected to create value by generating returns above the required rate

Answer

The project will incur a net loss over its lifetime

Answer

The project's payback period is less than one year

Question 21

What is the essence of the Internal Rate of Return (IRR)?

Accepted Answer

The discount rate that equates the present value of future cash flows to the initial investment

Answer

The steady rate of return the project will generate each year

Answer

The cutoff rate against which the NPV is compared

Question 22

A project demands an initial investment of $10,000 and is projected to generate cash inflows of $3,000 annually for 5 years. Which option is closest to the project's IRR?

Accepted Answer

12.5%

Answer

7.5%

Answer

17.5%

Answer

20.0%

Question 23

When relying on IRR to evaluate investment opportunities, which decision rule should be followed?

Accepted Answer

Accept projects with an IRR exceeding the required rate of return

Answer

Prioritize projects with the lowest payback period, irrespective of IRR

Answer

Accept projects with an IRR below the discount rate

Question 24

What is a potential shortcoming of using IRR as the sole criterion for project selection?

Accepted Answer

It may yield inconsistent rankings for projects with varying scales or cash flow timing

Answer

It ignores the impact of inflation on future cash flows

Question 25

Which scenario could lead to conflicting rankings of projects using NPV and IRR?

Accepted Answer

Projects with significantly different initial investments

Answer

Projects with the same discount rate applied

Answer

Projects with positive NPV values

Question 26

In capital budgeting, the appropriate discount rate for NPV calculations should reflect:

Accepted Answer

The company's cost of capital, representing the return expected by investors

Answer

The prevailing inflation rate

Answer

The average return of the company's previous projects

Question 27

How is the relationship between NPV and shareholder wealth best described?

Accepted Answer

Projects with positive NPV are typically expected to enhance shareholder wealth

Answer

Maximizing NPV always leads to a decrease in shareholder wealth

Answer

NPV is not a reliable indicator of shareholder wealth creation

Question 28

A project requires an initial investment of $120,000 and is projected to generate cash flows of $40,000 per year for 6 years. Assuming a discount rate of 10%, calculate the project's Net Present Value (NPV).

Accepted Answer

$19,183

Answer

-$19,183

Answer

$60,000

Answer

$30,000

Question 29

What is the Internal Rate of Return (IRR) of a project?

Accepted Answer

The discount rate that makes the Net Present Value (NPV) of the project equal to zero.

Answer

The minimum rate of return required by investors to make the project worthwhile.

Answer

The average annual rate of return generated by the project.

Answer

The rate of return achieved by the project in its best-case scenario.

Question 30

A project has an IRR of 15% and a required rate of return of 12%. Which of the following statements is TRUE?

Accepted Answer

The project is financially viable because its IRR exceeds the required rate of return.

Answer

The project is only viable if the required rate of return is lowered to 15%.

Answer

The project's profitability cannot be determined based solely on IRR and the required rate of return.

Answer

The project is not financially viable because the IRR is lower than the required rate of return.

Question 31

Which of the following scenarios would generally lead to a higher NPV for a project?

Accepted Answer

Decreasing the discount rate.

Answer

Decreasing the expected cash flows.

Answer

Increasing the initial investment.

Answer

Shortening the project lifespan.

Question 32

What is a key advantage of using the IRR method compared to the NPV method?

Accepted Answer

IRR provides a percentage return, making it easier to compare different investment opportunities.

Answer

IRR considers the time value of money more accurately than NPV.

Answer

IRR is less sensitive to changes in the discount rate.

Answer

IRR is simpler to calculate than NPV.

Question 33

A project has an NPV of $50,000 and an IRR of 18%. The required rate of return is 10%. Which statement is TRUE?

Accepted Answer

The project should be accepted because both NPV and IRR indicate profitability.

Answer

The project should be rejected because the NPV is positive.

Answer

The project should be rejected because the IRR is higher than the required rate of return.

Answer

The project's profitability cannot be determined based solely on NPV and IRR.

Question 34

A project's IRR is calculated to be 12%. What does this mean in terms of the project's expected return?

Accepted Answer

The project is expected to generate a 12% annual return on average.

Answer

The project's IRR is a theoretical value and does not guarantee a specific return.

Answer

The project's actual return will always be 12% regardless of market conditions.

Answer

The project is guaranteed to generate a 12% return every year.

Question 35

Which of the following is NOT a limitation of the IRR method?

Accepted Answer

It considers the time value of money.

Answer

It does not consider the scale of the project.

Answer

It assumes constant reinvestment rates.

Answer

It can lead to multiple IRR values for a project.

Question 36

A project has a payback period of 3 years, an NPV of $20,000, and an IRR of 15%. The required rate of return is 10%. What is the best decision based on these metrics?

Accepted Answer

Accept the project as it meets all financial criteria.

Answer

Reject the project as the payback period is too long.

Answer

Reject the project as the IRR is too high.

Answer

More information is needed to make a decision.

Question 37

A company is considering two mutually exclusive projects. Project A has an NPV of $50,000 and an IRR of 18%, while Project B has an NPV of $40,000 and an IRR of 20%. Which project should the company choose?

Accepted Answer

Project A, as it has a higher NPV despite a lower IRR.

Answer

Either project, as they both have positive NPVs.

Answer

Project B, as it has a higher IRR.

Answer

The decision cannot be made solely on NPV and IRR, further analysis is needed.

Question 38

What is the primary purpose of calculating the Net Present Value (NPV) of a project?

Accepted Answer

To determine if the project's future cash flows, discounted to their present value, exceed the initial investment.

Answer

To estimate the payback period of an investment.

Answer

To determine the project's profitability in nominal terms.

Answer

To calculate the accounting rate of return on an investment.

Question 39

A project requires an initial investment of $50,000 and is projected to generate annual cash inflows of $20,000 for three years. Assuming a discount rate of 10%, what is the project's NPV (rounded to the nearest dollar)?

Accepted Answer

$4,882

Answer

$50,000

Answer

$10,000

Answer

-$4,882

Question 40

Which statement accurately describes a project with a positive Net Present Value (NPV)?

Accepted Answer

The project is expected to generate a return that exceeds the required rate of return, creating value for the company.

Answer

The project's initial investment is fully recovered within the project's life.

Answer

The project has a payback period of less than one year.

Answer

The project is guaranteed to be profitable in all scenarios.

Question 41

What does the Internal Rate of Return (IRR) represent?

Accepted Answer

The discount rate that makes the Net Present Value (NPV) of a project equal to zero.

Answer

The average annual profit generated by a project.

Answer

The required rate of return for an investment to be considered.

Answer

The rate of return achieved by the project after accounting for inflation.

Question 42

A project has an initial cost of $100,000 and generates annual cash inflows of $40,000 for three years. What is the project's approximate Internal Rate of Return (IRR)?

Accepted Answer

8%

Answer

12%

Answer

40%

Answer

-8%

Question 43

When evaluating investment projects using the Internal Rate of Return (IRR), which project is generally preferred, assuming all other factors are equal?

Accepted Answer

The project with the highest IRR, as long as it exceeds the minimum acceptable rate of return.

Answer

The project with an IRR closest to zero.

Answer

The project with an IRR that matches the company's cost of capital.

Answer

The project with the lowest IRR.

Question 44

Which of the following scenarios could lead to multiple Internal Rates of Return (IRRs) for a project?

Accepted Answer

Projects with non-conventional cash flows, where there are multiple sign changes in the cash flow stream.

Answer

Using a discount rate that is too high.

Answer

Projects with a very long lifespan.

Answer

Projects with a high initial investment compared to subsequent cash flows.

Question 45

What is the relationship between Net Present Value (NPV) and Internal Rate of Return (IRR)?

Accepted Answer

If a project has a positive NPV, its IRR will be greater than the discount rate used to calculate the NPV.

Answer

NPV and IRR are independent of each other.

Answer

A higher NPV always indicates a higher IRR.

Answer

NPV and IRR are always equal.

Question 46

When choosing between two mutually exclusive projects with different lifespans, which method is generally preferred to ensure a fair comparison?

Accepted Answer

Equivalent Annual Annuity (EAA), which calculates the annual equivalent value of each project over its lifespan.

Answer

Payback Period, which measures the time it takes to recover the initial investment.

Answer

Accounting Rate of Return (ARR), which measures the average annual profit as a percentage of the initial investment.

Question 47

What is a key advantage of using discounted cash flow (DCF) methods like NPV and IRR over non-DCF methods for evaluating projects?

Accepted Answer

DCF methods explicitly consider the time value of money, meaning that cash flows received in the future are valued less than those received today.

Answer

DCF methods are more accurate than non-DCF methods in all situations.

Answer

DCF methods are simpler to calculate than non-DCF methods.

Answer

DCF methods do not require estimating future cash flows, making them easier to use.