Question

Briefly answer the questions that follow.

1. 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?

2. 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?

3. 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?           

4. Briefly explain the benefits of a portfolio.

Answer 1

1.
Decide based on NPV method as it is a superior method hence choose the higher NPV project

2.
If a project has normal cash flows, it results in one IRR
We can use goal seek or graphical method or enter guess values

3.
No the discount rate should be based on the riskiness of the project. WACC is appropriate for projects with riskienss same as the overall firm. Here, we should use a discount rate higher than WACC

4.
One can achieve diversification as portfolio lowers the risk keeping return constant. The diversifiable risk can be eliminated to a large extent.