1. Net Present Value is considered a better method than Internal Rate of Return
ID: 2628463 • Letter: 1
Question
1. Net Present Value is considered a better method than Internal Rate of Return for all of the following reasons except __________.
a) IRR may misrank mutually exclusive projects of different size
b) IRR can not be used when capital rationing exists
c) IRR may have multiple IRR's if the project is nonnormal
d) IRR assumes cash flows can be reinvested at the project's IRR
2. Which of the following is true for normal projects if the cost of capital is positive?
a. If a project's IRR is positive, then its Profitability Index will greater than 1
b. If a project's NPV is negative, then its Payback period will not exist
c. If a project's NPV is positive, then its Profitability Index will be positive
d. If a project's IRR is positive, then its Discounted Payback period will exist
3. __________ is a method used to compare two repeatable projects with different lives.
4. The __________ is the rate at which two projects have the same NPV is found by calculating the IRR of the difference in the cash flows of two projects.
5. Which of the following is NOT considered a relevant concern in determining incremental cash flows for a new product?
Explanation / Answer
1. IRR (Internal Rate of Return) of project is the rate at which the NPV (Net Present Value) of project becomes zero. In a project where cash flows are non-normal means cash outflows occur sometime during the project life, multiple IRR may occur and there is no way to know which IRR is correct.
Thus, option c is correct.
2. Net Present Value of the project is the difference of present value of future cash outflows and initial investment, if the present value of future cash flows will be greater than the initial investment in that case the NPV of project will be positive.
The profitability index is the relationship (ratio) of present value of future cash flows and initial investment. The PI greater than 1 will occur if the NPV is positive because here the Present Value of future cash flows will be more than initial investment.
Thus, option c is correct.
3. In Equated Annual Annuity the projects net present value is present in the equal cash flows for the life of the project which makes easy to compare projects with different lives.
Thus, option 2 is correct.
4. Cross over rat e is the rate at which the NPV of two projects will be equal, it is the IRR of the difference in the cash flows of two projects.
Thus, correct answer is option 3.
5. Sunk cost is the cost that is already spent in past and cannot be recovered in the future and they are irrelevant in future decision making.
Thus, option 4. is correct.
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