Question

Briefly answer in Excel the questions that follow. An answer of 1-3 sentences for each question should suffice.

a) You are considering two mutually exclusive projects. The NPV for project one is positive and higher than the NPV for project two, while the IRR for project two is higher than that for project one. Which project should the firm accept and why?

b) When does a project result in only one IRR? If a project has more than one IRR, how can we use Excel to find the multiple IRRs?

c) A diversified, low-risk firm is considering investing in a high-risk project in a new industry. Is it appropriate to use the firm’s WACC as the discount rate when evaluating this project? Why or why not?

d) Briefly explain the benefits of a portfolio.

Answer 1

a)

The firm should accept project 1 as it has higher NPV. NPV is better than IRR in choosing mutually exclusive projects.

b)

When a project has cash flows where there is only one change of sign , in that case there is only one IRR. Formula to get IRR in excel example

A

B

1

CF0

-200

2

CF1

100

3

CF2

300

4

CF3

-100

Excel formul

Guess Values

IRR

34.07%

IRR(B1:B4,0%)

0%

-67.90%

IRR(B1:B4,-50%)

-50%

Using guess values we can get multiple IRRs

c.

No WACC is not appropriate. Because the project is more risky a risk premium must be added to WACC to evaluate the project

d.

Portfolio helps in minimising standard deviation or risk. An optimal portfolio minimizes the unsystematic risk . This is because correlation may be less than 1