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cost of capital

1) Projects c and d both have normal cash flows. In other words, there is an up-front cost followed over time by a series of positive cash flows. Both projects have the same risk and a WACC equal to 10 percent. However, Project c has a higher internal rate of return than Project d. Assume that changes in the WACC have no effect on the projects? cash flow levels. Which of the following statements is most correct?

a. Project c must have a higher net present value than Project d.
b. If Project c has a positive NPV, Project d must also have a positive NPV.
c. If Project C's WACC falls, its internal rate of return will increase.
d. If Projects c and d have the same NPV at the current WACC, Project d would have a higher NPV if the WACC of both projects was lower.
e. Statements b and c are correct.

Reason for answer ?

2) Marlowe corp is considering two mutually exclusive projects. Project A has an internal rate of return of 18 percent, while Project B has an internal rate of return of 30 percent. The two projects have the same risk, the same cost of capital, and the timing of the cash flows is similar. Each has an up-front cost followed by a series of positive cash flows. One of the projects, however, is much larger than the other. If the cost of capital is 16 percent, the two projects have the same net present value (NPV); otherwise, their NPVs are different. Which of the following statements is most correct?

a. If the cost of capital is 12 percent, Project B will have a higher NPV.
b. If the cost of capital is 17 percent, Project B will have a higher NPV.
c. Project B is larger than Project A.
d. Statements a and c are correct.
e. Statements b and c are correct

Reason for answer?

Solution Preview

I have added the explanations with each statement.

1) a. Project c must have a higher net present value than Project d.
This may not be correct if the investment in project c is low and investment in project d is higher.

b. If Project c has a positive NPV, Project d must also have a positive NPV.
This may not be correct howver the reverse is true i.e. if project d has a positive NPV, project d will have a positive NPV.

c. If Project C's WACC falls, its internal rate of return will increase.
This is incorrect. IRR is not affected by the WACC.

d. If Projects c and d ...

Solution Summary

Capital Budgeting is assessed.

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