e.
For a conflict to exist between NPV and IRR, one project must have an
increasing stream of cash flows over time while the other has a
decreasing stream. If both sets of cash flows are increasing or
decreasing, then it would be impossible for a conflict to exist, even
if one project is larger than the other.
Page 128
Chapter 11:
The Basics of Capital Budgeting

NPV profiles
Answer: b
MEDIUM/HARD
59
.
Project X’s IRR is 19%, and Project Y’s IRR is 17%.
The projects have the
same risk and the same lives, and their cash flows are constant over their
lives.
If the WACC is 10%, Project Y has a higher NPV than Project X.
Given this information, which of the following statements is CORRECT?
a.
The crossover rate between the two projects must be less than 10%.
b.
The crossover rate between the two projects must be greater than 10%.
c.
If the WACC is 8%, Project X will have the higher NPV.
d.
If the WACC is 18%, Project Y will have the higher NPV.
e.
Project X is larger in the sense that it has the higher initial cost.
NPV profiles
Answer: e
HARD
60
.
Assume that Projects S and L both have normal cash flows, and those cash
flows are not affected by the WACC used to evaluate them.
Moreover, the
projects have the same risk, hence both are evaluated with the same WACC,
10%. However, Project S has a higher IRR than Project L. Which of the
following statements is CORRECT?
a.
Project S must have a higher NPV than Project L.
b.
If Project S has a positive NPV, Project L must also have a positive NPV.
c.
If the WACC falls, each project’s IRR will increase.
d.
If the WACC increases, each project’s IRR will decrease.
e.
If Projects S and L have the same NPV at the current WACC, 10%, then
Project L, the one with the lower IRR, would have a higher NPV if the
WACC used to evaluate the projects declined.
NPV profiles
Answer: c
HARD
61
.
Which of the following statements is CORRECT?
Assume that all projects
being considered have normal cash flows and are equally risky.
a.
If a project’s IRR is equal to its WACC, then under all reasonable
conditions, the project’s NPV must be negative.
b.
If a project’s IRR is equal to its WACC, then under all reasonable
conditions, the project’s IRR must be negative.
c.
If a project’s IRR is equal to its WACC, then under all reasonable
conditions, the project’s NPV must be zero.
d.
There is no necessary relationship between a project’s IRR, its WACC,
and its NPV.
e. When evaluating mutually exclusive projects, those projects with
relatively long lives will tend to have relatively high NPVs when the
cost of capital is relatively high.
Chapter 11:
The Basics of Capital Budgeting
Page 129

NPV profiles
Answer: d
HARD
62
.
A company is choosing between two projects.
The larger project has an
initial cost of $100,000, annual cash flows of $30,000 for 5 years, and
an IRR of 15.24%.
The smaller project has an initial cost of $50,000,
annual cash flows of $16,000 for 5 years, and an IRR of 16.63%.
The
projects are equally risky. Which of the following statements is
CORRECT?

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