Question

1. At a discount rate of 10% the net present value of a project is $5,000. From this we can conclude that the:

a. project's IRR equals 10%.

b. project's IRR is greater than 10%.

c. project's IRR is also $5,000.

Answer 1

Solution:

The relationship between NPV, discount rate and IRR of a project can be explained as follows :         

When the IRR is equal to Discount rate, the Net present value of the project is equal to zero.

When the IRR is lower than the Discount rate, the Net present value of the project is less than zero i.e., is negative.

When the IRR is greater than the Discount rate, the Net present value of the project is greater than zero i.e., is positive.

As per the information given in the question, at a discount rate of 10 %, the NPV = $ 5,000.

Since the NPV of the project at a discount rate of 10 % is greater than zero i.e., positive, the IRR of the project will be greater than 10 %

Thus the solution is Option b. project's IRR is greater than 10%.

The other options are incorrect due to the following reasons:

a.project's IRR equals 10%.

Since the NPV of the project is greater than zero, the Project’s IRR cannot be equal to the discount rate of 10 %

c. project's IRR is also $5,000.

IRR is a rate at which the NPV of the project is equal to zero. Thus IRR being a rate cannot be $ 5,000