Investment Decisions Flashcards

A project has an IRR of 15% and the company's cost of capital is 12%. The project should be:

Answer: Accepted because IRR exceeds cost of capital

When IRR exceeds the cost of capital, the project generates returns above the minimum required rate and should be accepted.

Which statement about NPV and IRR is correct when evaluating independent projects?

Answer: They give the same accept/reject decision

For independent projects, NPV and IRR give consistent decisions: if IRR exceeds the cost of capital, NPV is positive, and both methods recommend acceptance.

The discount rate that makes a project's NPV equal to zero is the:

Answer: Internal rate of return

The IRR is defined as the specific discount rate at which the project's NPV equals exactly zero.

When two mutually exclusive projects have conflicting NPV and IRR rankings, which method should be preferred?

Answer: NPV, because it measures absolute value added to the firm

NPV is preferred for mutually exclusive projects because it directly measures the absolute increase in firm value, aligning with the wealth-maximization objective.

To calculate a project's NPV, cash flows are:

Answer: Discounted to present value, summed, and then reduced by the initial investment

NPV requires discounting each future cash flow to present value, summing those present values, and subtracting the initial investment.

The modified internal rate of return (MIRR) addresses which key limitation of IRR?

Answer: IRR unrealistically assumes reinvestment at the project's IRR rate

MIRR assumes interim cash flows are reinvested at the cost of capital rather than the IRR, providing a more realistic measure of project returns.