Question

Question 30 1.5 pts A firm with cost of capital of 10 percent is evaluating two mutually exclusive projects and constructed the following NPV profile: $100 NPV(A) .......NPV(B) 50 + Net Present Value “ ..... $0 ....sete 0% 5% 10% 15% 20% 25% 30% 35% 40% -$50 Dis count Rate True or false: Project B has the higher IRR and therefore would maximize shareholder wealth if selected over project A. O false O true

Answer 1

Answer: TRUE Reason: $100 NPV(A) ------ NPV(B) $50 Net Present Value 0% 5% 10% 15% 20% 25% 30% 35% 40% - $50 Dis count Rate IRR stands for Internal Rate of Return which is nothing but the discount rate that makes NPV of the project equals to zero. In other words, it is the discount rate at which present value of future net incomes is equal to initial investment made. IRR rule says that higher the IRR, higher the acceptability of a project. In other words, if IRR is equal to or higher than project's minimum required return rate, this project shall be accepted; otherwise, it shall be rejected. When two projects are evaluated using IRR as an evaluation tool, the project that yields the higher IRR shall be preferred. In the given scenario, Project-A's IRR is 20% whereas Project-B's IRR is 30% and so selecting Project-B will increase wealth of the investors. Given statement is true.