Question

A firm is considering three different projects for investment.  Project A will require an initial investment of...

A firm is considering three different projects for investment.  Project A will require an initial investment of \$100,000 today and will generate annual cash flows of \$25,000 for a five-year period.  Project B will require an initial investment of \$150,000 today will generate annual cash flows of \$35,000 for a five-year period.  Project C will require an initial investment of \$275,000 today, and will generate a cash flow of \$75,000 in the first year.  Cash flows will grow by 3% per year for project C over the five-year period.

The three projects are contingent for the firm.  What is the maximum cost of capital for the firm if the firm wants to invest?

Question 18 options:

 9.41% 16.98% 10.19% 11.47% 13.44%

Solution.>

The correct answer is option (E) ie. 13.44%

Acceptance of the project acc to the IRR Rule depends on the decision criteria where the IRR should be greater than the cost of capital. Those projects are selected where the IRR > Cost of capital.

Since the maximum IRR of the three projects is 13.45%. Hence, the maximum cost of capital to accept this project will be just less than the IRR of 13.45%.

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