1. Consider the MIRR and the IRR. Which of the following is true? a. There is al
ID: 2811733 • Letter: 1
Question
1. Consider the MIRR and the IRR. Which of the following is true?
a. There is always only 1 IRR
b. For mutually exclusive projects both the MIRR and IRR provide better recommendations than the NPV
c. The reinvestment rate for the IRR is the WACC
d. For independent projects both the MIRR and IRR provide the same recommendations as the NPV
2. Consider the following information for projects K and W:
Project K: NPV = $1,500 IRR = 20%
Project W: NPV = $2,500 IRR = 15%
Assume Project K and Project W are independent projects with a WACC = 10%. Which of the following is true?
a. Both Projects K and W should be enacted since both have a positive NPV
b. Only Project W should be enacted since it has the highest NPV
c. Only Project K should be enacted since it has the highest IRR
d. Neither Project K or W should be enacted since both have a positive NPV
3. Consider the following information for projects K and W:
Project K: NPV = $1,500 IRR = 20%
Project W: NPV = $2,500 IRR = 15%
Assume Project K and Project W are mutually exclusive projects with a WACC = 10%. Which of the following is true?
a. Both Projects K and W should be enacted since both have a positive NPV
b. Only Project W should be enacted since it has the highest NPV
c. Only Project K should be enacted since it has the highest IRR
d. Neither Project K or W should be enacted since both have a positive NPV
4. Consider the following series of cash flows:
Cash Flow: -50 20 10 10 20 20
Time: 0 1 2 3 4 5
If you are using a 10% discount rate, which of the following is true?
a. Payback and discounted payback will both be less than 0
b. Payback will be larger than discounted payback
c. Payback and discounted payback will be the same
d. Payback will be smaller than discounted payback
5. A mining company is considering a new project. Because the mine has received a permit, the project would be legal; but it would cause significant harm to a nearby river. The firm could spend an additional $10 million at year 0 to mitigate the environmental problem, but it would not be required to do so. However, if the firm does not deal with the problem at year 0 they would face a lawsuit at the end of the project (year 5) at a cost of $20 million. Developing the mine (without mitigation) would cost $60 million and the expected cash inflows would be $20 million for 5 years. The weighted average cost of capital (WACC) is 12%. Below is a summary of possible outcomes:
NPV with mitigation costs at time 0 included = $2.1 million
NPV without mitigation costs at time 0 and a lawsuit included in year 5 = $0.75 million
Should the project be undertaken? If so, should the firm do the mitigation at time 0?
a. No, the NPV’s are positive for every possible scenario.
b. Yes, the project should be undertaken and no mitigation should be conducted at time 0.
c. Yes, the project should be undertaken and the mitigation expense should be conducted at time 0.
d. No, the project is too risky and should not be undertaken.
Explanation / Answer
Answer:
(1).
D.For independent projects both MIRR and IRR provide the same recommendations as the NPV.
(investement rate for IRR is IRR itself, so A is false)
(For certain projects multiple IRR's arise, so B is false).
(For mutually exclusive projects NPV is a better choice than IRR and MIRR, so C is false).
(2).
The correct option is A
Since both the projects are independent and both the projects have a positive NPV as well as IRR higher than WACC both the projects are beneficial for the company.
(3).
Since both the projects are mutually exclusive;the project having a higher NPV is chosen.Hence the correct option is
b. Only Project W should be enacted since it has the highest NPV.
High NPV ensures higher Net present value of inflows.
(4).
Hence Payback period=Last period with a negative cumulative cash flow+(Absolute value of cumulative cash flows at that period/Cash flow after that period).
=3+(10/20)=3.5 years
Hence discounted payback period=4+(2.39/12.42)=4.19 years
Hence the correct option is D.
(5).
Case 1: Without mitigation
CF0 = -60 – 10 = -70, CF1-5 = 20
r = WACC = 12%
NPV = -60 + (20/0.12)*(1 – 1/1.12^5) = $12.095524 million
At r = IRR, NPV = 0; as the cash flow is uniform over the period, we can take it as PMT.
PV = 60, PMT = 20, N = 5, FV = 0; compute r = 0.198577 = 19.86%
IRR = 19.86%
Case 2: With mitigation
CF0 = -60, CF1-5 = 21
NPV = -70 + (21/0.12)*(1 – 1/1.12^5) = $5.700300 million
PV = 70, PMT = 21, N = 5, FV = 0; compute r = 0.152382 = 15.24%
IRR = 15.24%
Though both cases generate positive NPV, performing mitigation reduces NPV. Therefore, mitigation is not advisable in terms of monetary benefit of the project.
As both projects have positive NPV, either can be undertaken. But as mitigating is not compulsory, firm should not do the mitigation and can generate higher wealth without mitigation.
Option b is the answer.
Year Cash flows Cumulative cash flows 0 (50) (50) 1 20 (30) 2 10 (20) 3 10 (10) 4 20 10 5 20 30Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.