Question

Mento Mills is considering two mutually exclusive projects. The Amber Project has an internal rate of return (IRR) of 12 percent, while Bukka Project has an IRR of 14 percent. The two projects have very similar risk. Both projects have the same NPV when the cost of capital is 7 percent. Assume each project has an initial cash investment followed by a series of cash returns.

The following are possible statements that can be made about this information:

I. If the cost of capital is 13 percent, Bukka's NPV will be higher than Amber's NPV.

II. If the cost of capital is 9 percent, Bukka's NPV will be higher than Amber's NPV.

III. By increasing the cost of capital, Bukka's NPV will decrease more slowly than Amber's NPV.

IV. Bukka's initial cash investment is less than Amber's initial cash investment.

Which is the best conclusion about these statements?

Select one:

a. Statements I and III are correct.

b. Statements I and II are correct.

c. Only statement II is correct.

d. All the statements are correct.

e. Only statement I is correct.

Answer 1

I am giving following example to prove my option.

Discount rate	NPV of Project Bukka	NPV of Project Amber
0%	360000	450000
2%	282573.486	342463.175
4%	220261.9476	255919.3716
6%	169640.9636	185612.4494
8%	128141.2328	127973.9344
10%	93818.86223	80303.97532

As we can see that the cross over rate is somewhere 7% where NPV of the both project will be equal once the discount rate increases over 7% then NPV of Bukka project is start increasing in compare to Amber. Which make both option I & II correct. Then  we can also observe that the NPV is decreasing lesser to Bukka in compare to Amber which make option III correct.

Thus the correct answer for this question will be All the statement are correct that is option d.