true or false 14. Conflicts between two mutually exclusive projects occasionally
ID: 1175598 • Letter: T
Question
true or false
14. Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks one project higher but the IRR method puts the other one first. In theory, such conflicts should be resolved in favor of the project with the higher NPV.
13. Consider the WACC formula, there are three methods for estimating the cost of common stock from retained earnings: 1) the CAPM method, 2) the DCF method, and 3) the preferred stock-yield-plus-risk-premium method.
11.In the Weighted Average Cost of Capital formula, the after-tax cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt.
10. Consider the WACC formula, if the required rate of return on preferred stock increases, holding all else equal, the WACC increases.
Explanation / Answer
(14) The NPV and IRR criteria give mostly similar verdicts while choosing between mutually exclusive projects except in situations where there is no IRR or the direction of project cash flows change multiple time. However, in situations of conflict the NPV criteria verdict is selected and the IRR verdict is rejected as a higher NPV implies accrual of higher value upon undertaking the project. Hence, this statement is true. Further, NPV verdicts are unchanged in cases where there is no IRR or multiple IRRs.
(13) The cost of common stock can be calculated by using the CAPM method, DCF method and yield on the firm's long-term bond + Risk-Premium Method. Hence, the given statement is false.
(11) In WACC formula, the after-tax cost of debt is indeed one minus the tax rate multiplied by the interest rate on new debt. The interest rate in most cases, however, is not the bond's coupon rate but its yield. Hence, the statement is true.
(10) The preferred stock return is one of the components of the WACC and if the latter increases the former is bound to increase. Hence, this statement is also true.
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