You Are Considering Two Mutually Exclusive, Equally Risky, Projects

question 84

Multiple Choice

You are considering two mutually exclusive, equally risky, projects. Both have IRRs that exceed the WACC. Which of the following statements is CORRECT? Assume that the projects have normal cash flows, with one outflow followed by a series of inflows.

• A) If the two projects' NPV profiles do not cross, then there will be a sharp conflict as to which one should be selected.
• B) If the cost of capital is greater than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects. The same project will rank higher by both criteria.
• C) If the cost of capital is less than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects. The same project will rank higher by both criteria.
• D) For a conflict to exist between NPV and IRR, the initial investment cost of one project must exceed the cost of the other.
• E) For a conflict to exist between NPV and IRR, one project must have an increasing stream of cash flows over time while the other has a decreasing stream. If both sets of cash flows are increasing or decreasing, then it would be impossible for a conflict to exist, even if one project is larger than the other.

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Definitions:

Hedge Ratio

A ratio used to measure the proportion of an investment's risk that is being mitigated by a hedge, aiming to reduce potential losses.

At-the-money

A term used in options trading to describe an option where the market price of the underlying asset is equal to the option's strike price.

Straddle Position

An investment strategy involving the purchase or sale of both a call option and a put option on the same asset, with identical strike prices and expiration dates, used to bet on volatility.

Delta-hedging

A strategy used in options trading to reduce the risk of price movements of the underlying asset by offsetting positions.