Your Assistant Has Just Completed an Analysis of Two Mutually

question 6

Multiple Choice

Your assistant has just completed an analysis of two mutually exclusive projects. You must now take her report to a board of directors meeting and present the alternatives for the board's consideration. To help you with your presentation, your assistant also constructed a graph with NPV profiles for the two projects. However, she forgot to label the profiles, so you do not know which line applies to which project. Of the following statements regarding the profiles, which one is most reasonable?

• A) If the two projects have the same investment cost, and if their NPV profiles cross once in the upper right quadrant, at a discount rate of 40 percent, this suggests that a NPV versus IRR conflict is not likely to exist.
• B) If the two projects' NPV profiles cross once, in the upper left quadrant, at a discount rate of minus 10 percent, then there will probably not be a NPV versus IRR conflict, irrespective of the relative sizes of the two projects, in any meaningful, practical sense (that is, a conflict which will affect the actual investment decision).
• C) If one of the projects has a NPV profile which crosses the X-axis twice, hence the project appears to have two IRRs, your assistant must have made a mistake.
• D) Whenever a conflict between NPV and IRR exist, then, if the two projects have the same initial cost, the one with the steeper NPV profile probably has less rapid cash flows. However, if they have identical cash flow patterns, then the one with the steeper profile probably has the lower initial cost.
• E) If the two projects both have a single outlay at t = 0, followed by a series of positive cash inflows, and if their NPV profiles cross in the lower left quadrant, then one of the projects should be accepted, and both would be accepted if they were not mutually exclusive.

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Definitions:

Operating Income

The profit realized from a business's ongoing operations, calculated before interest and taxes.

Statement of Cash Flows

A financial statement that summarizes the amount of cash and cash equivalents entering and leaving a company.

Shares of Stock

Units of ownership interest in a corporation or financial asset, representing an equal proportion of the company's capital.

Comparative Balance Sheets

Financial statements that present the financial position of a company at different points in time, allowing for analysis of trends and changes.