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:

Depreciation Value

The reduction in value of an asset over time due to wear and tear or obsolescence.

Internal Rate of Return (IRR)

The yield rate at which all of a project's cash flows' net present value becomes null.

Required Return

The minimum expected return an investor views as acceptable for an investment, based on its risk level.

Depreciation Rate

The rate at which an asset loses its value over time, often used for tax and accounting purposes to spread the cost of an asset over its useful life.