You are on the staff of Camden Inc. The CFO believes project acceptance should b
ID: 2619822 • Letter: Y
Question
You are on the staff of Camden Inc. The CFO believes project acceptance should be based on the NPV, but Steve Camden, the president, insists that no project should be accepted unless its IRR exceeds the project's risk-adjusted WACC. Now you must make a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000 at the end of Year 1 and -$100,000 at the end of Year 2. The president and the CFO both agree that the appropriate WACC for this project is 10%. At 10%, the NPV is $2,355.37, but you find two IRRs, one at 6.33% and one at 527%, and a MIRR of 11.32%. Which of the following statements best describes your optimal recommendation, i.e., the analysis and recommendation that is best for the company and least likely to get you in trouble with either the CFO or the president?
A) You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC.Explanation / Answer
Answer is Option C
NPV is an absolute approach compared to IRR and MIRR method which are relative methods for project assessment and selection. So NPV approach should be given presedence over other methods.
Higher or a positive NPV implies project will add value to the firm and should be selected.
Other than that, MIRR is a better approach than IRR. IRR assumes that the reinvestment rate for cash flows is IRR itself which is a drawback. MIRR gives flexibility to assume a seperate reinvestment rate.
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