Question

A is considering the investment in a project that has an initial cash outlay followed by...

A is considering the investment in a project that has an initial cash outlay followed by a series of net cash inflows. The business applied the NPV and IRR methods to evaluate the proposal but, after the evaluation had been undertaken, it was found that the correct cost of capital figure was lower than that used in the evaluation. What will be the effect of correcting for this error on the NPV and IRR figures? Effect on NPV IRR

a) Decrease Decrease

b) Decrease No change

c) Increase Increase

d) Increase No Change

e) Increase Decrease

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Answer #1
Using a wrong cost of capital figure would only affect NPV (Net Present value)
Net Present value is calculated using cost of Capital. The cash flows are discounted at cost of capital.
The lower the cost of capital, the higher the PV factor and NPV.
Correcting the error and using correct cost of capital figure would lead to higher PV factor and increased NPV.
The internal rate of return (IRR) would be unaffected by Cost of Capital.
Option D Increase No Change is correct
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