1. Which of the following is a valid reason why your firm might select a project
ID: 2762959 • Letter: 1
Question
1. Which of the following is a valid reason why your firm might select a project with a lower IRR than the firm’s cost of capital?
A: Because the firm operates under financial constraints
B: Because the project has more volatile cash flows than other projects
C: Because the project is less risky than most projects the firm undertakes
D: Because the firm is a small, single-business enterprise
E: None of the above
2. Another project comes in that is virtually identical to the previous project, except its costs derive primarily from fixed costs rather than variable costs. Do you expect the project-specific WACC to be higher or lower if you use its debt capacity to adjust the divisional WACC?
3. Which of the following are valid reasons to use a hurdle rate for projects that is substantially higher than a firm’s WACC?
A: To provide a margin for error in the estimation of WACC
B: To provide a cushion against inflated estimated cash flows due to bias
C: To represent an opportunity cost based on other available projects
D: To help narrow the field for project sponsors
E: All of the above
4. Your firm operates three lines of business that operate in entirely different industries. Projects within each industry face mostly the same business environment and have similar risk profiles, and your company has to quickly evaluate dozens of projects every week. Each is analyzed by one of a handful of different business development specialists, all of whom face a bonus structure based on their successful identification of projects the firm winds up investing in. Which of the following approaches for cost of capital are best suited to this environment?
A: One firm-wide cost of capital
B: Three divisional costs of capital
C: Project-specific costs of capital
D: There is not enough information to answer this question
E: None of the above
Explanation / Answer
1. None of the above : In general, the IRR method indicates that a project whose IRR is greater than or equal to the firm's cost of capital should be accepted, and a project whose IRR is less than the firm's cost of capital should be rejected
3. To represent an opportunity cost based on other available projects
4. None of the above
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