Question

Assume a new project requires an initial investment of $10 million dollars, with ensuing cash flows of $2, $4 and $5 million in years 1, 2 and 3. Assuming the company's WACC is 10%, which of the following statements is true?

The firm should reject the project, as the IRR is lower than the WACC.

The firm should accept the project, as the IRR is higher than the WACC.

The firm should accept the project, as the NPV is positive.

The firm should accept the project, as the NPV is negative.

None of these statements are true.

Answer 1

Net present value is solved here using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$10 million. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter cost of weighted average cost of capital of 10%.
• Press the down arrow and CPT buttons to get the net present value.

The net present value is -$1.12.

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$10 million. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of project is 4.31%.

The net present technique is used to make capital decision. The project should be rejected since it generates a negative net present value.

Hence, the answer is option e.

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