Question

Project A has an IRR of 15%. Project B has an IRR of 13%. Both projects have a cost of capital of 12%. Which of the following statements would be correct?

A. Both projects have a positive NPV. True or False? Explain

B. Project A must have a higher NPV than Project B, True or False? Explain.

C. If Project B has a higher NPV when cost of capital is 8%, then Project B must also have higher NPV if the cost of capital were more than 13%. True or False? Explain

Answer 1

A. True.

In the context of capital budgeting, the internal rate of return ( IRR ) is the discount rate at which the net present value ( NPV) of all cash flows of a project becomes zero.

The cost of capital is used as the MARR for discounting cash flows to compute the NPV.

As long as the respective IRRs of the projects exceed the cost of capital, the NPVs would be positive. When the cost of capital equals the IRR, NPV would be zero. When the cost of captal exceeds the IRR, NPV would be negative.

B. False. The NPV depends not only on the cost of capital, but also on the amount and the timing of the cash flows,the length of the project life, and the amount and timing of the investments involved.

C. False.

NPV decreases with increasing cost of capital.