Projected IRR can be less than the WACC

Show your work and/or provide supporting detail for short-answer problems.

Question 1
1. Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?
Answer

a. The projects regular payback increases as the WACC declines.

b. The projects NPV increases as the WACC declines.

c. The projects MIRR is unaffected by changes in the WACC.

d. The projects IRR increases as the WACC declines.

Question 2
1. Blanchford Enterprises is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC (and even negative), in which case it will be rejected.
Year: 0 1 2 3 4
Cash flows: -$1,000 $400 $400 $400 $400

Question 3
1. Johnson Corporation is considering a project that has the following cash flow data. What is the project's payback?
Year: 0 1 2 3 4 5
Cash flows: -$1,000 $300 $310 $320 $330 $340
Answer

Question 4
1. 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.
Answer

a. The longer a projects payback period, the more desirable the project is normally considered to be by this criterion.

b. The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.

c. One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money.

d. If a projects payback is positive, then the project should be rejected because it must have a negative NPV.

Question 5
1. Tapley Dental Associates is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected.
WACC = 10%
Year: 0 1 2 3 4 5
Cash flows: -$1,000 $300 $300 $300 $300 $300

Answer

Question 6
1. 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.
Answer

a. To find a projects IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the projects costs.

b. A projects regular IRR is found by discounting the cash inflows at the WACC to find the present value (PV), then compounding this PV to find the IRR.

c. If a projects IRR is greater than the WACC, then its NPV must be negative.

d. A projects regular IRR is found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting this TV at the WACC.

Question 7
1. Edison Electric Systems is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected.
WACC = 10%
Year: 0 1 2 3
Cash flows: -$1,000 $450 $460 $470
Answer

Question 8
1. Braun Industries is considering an investment project that has the following cash flows:
Year Cash Flow
0 -$1,000
1 400
2 300
3 500
4 400
The company's WACC is 10%. What is the project's payback, IRR, and NPV?
Answer

Question 9
1. Which of the following statements is CORRECT?
Answer

a. The NPV method does not consider all relevant cash flows, particularly, cash flows beyond the payback period.

b. The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR.

c. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the risk-free rate.

d. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR.

Question 10
1. 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.
Answer

a. The lower the WACC used to calculate it, the lower the calculated NPV will be.

b. If a projects NPV is greater than zero, then its IRR must be less than zero.

c. If a projects NPV is less than zero, then its IRR must be less than the WACC.

d. A projects NPV is found by compounding the cash inflows at the IRR to find the terminal value (TV), then discounting the TV at the WACC.

Question 11
1. A firm is analyzing two mutually exclusive projects with the following cash flows:
Project A Project B
Year Cash Flow Cash Flow
0 -$50,000 -$30,000
1 10,000 6,000
2 15,000 12,000
3 40,000 18,000
4 20,000 12,000

If the company's WACC is 10%, what is the NPV of the project with the highest IRR?
Answer

Question 12
1. Davis Corporation has an investment policy that requires acceptable projects to recover all costs within 3 years. The corporation uses the discounted payback method to assess potential projects and uses a WACC of 10%. The cash flows for two independent projects are shown below:
Project A Project B
Year Cash Flow Cash Flow
0 -$100,000 -$80,000
1 40,000 50,000
2 40,000 20,000
3 40,000 30,000
4 30,000 0

In which (if any) investment project (or projects) should the company invest?

Solution Summary

Solution discusses the projected IRR can be less than the WACC