Question

Projects T and Q are mutually-exclusive investment alternatives, Each project requires a net investment of $20,000, followed by a series of positive net cash flows. Both projects have a useful life equal to 10 years. Project T has an NPV of $36,000 at a 0% discount rate, while project Q has an NPV of $30,000 at 0%. Furthermore, at a discount rate of 15 percent, the two projects have identical positive NPVs. Given this, which of the following statements is incorrect?

1. Project Q has higher a IRR than Project T.

2. If the cost of capital is greater than the IRR of Project T, reject both projects.

3. If the cost of capital is 10%, select Project Q.

4. There are three circumstances that can cause project evaluation technique conflict. Even though the net cash flow stream is not given, the project evaluation technique conflict in this problem must be caused by differences in the magnitude of the cash flows, or cash flow timing differences.

5. The slope of Project Q's NPV profile is steeper than the slope of Project T's NPV profile.

Answer 1

If the cost of capital is greater than the IRR of Project T, reject both projects - This statement is incorrect. The IRR of project Q is higher than that of project T. This is because T has a higher NPV at i=0%than 1, but at i=15% both have equal NPV, suggesting than the NPV profile of T is decreasing at a faster pace than Q, and hence the IRR of Q>T. In short, the slope of Project Q's NPV profile is steeper than the slope of Project T's NPV profile. Hence, if IRR >T, then project Q could still have a positive NPV and project Q could still be accepted.

Project Q has higher a IRR than Project T - is correct for reasons mentioned above. If the cost of capital is 10%, select Project Q- This statement is correct as NPV IS equal only at i=15%, and below 15%, Project Q has higher IRR than project T.