Question

Which of the following statements is/are CORRECT?

1. MIRR is the discount rate that equates the PV of outflows with the FV of the cash inflows.

2. NPV is based on the assumption that a project’s cash flow are reinvested at IRR.

3. NPV profile is downward sloping line and identifies the relationship between NPV and IRR.

4. Scale difference and timing differences are two reasons lead to NPV profiles cross-over. (this is incorrect)

5. Both a and d are correct statements.

Which of the following should be considered when estimating FCF?

1. Sunk cost

2. Interest expenses of debt financing

3. Opportunity cost

4. All of the above should be considered (this is incorrect)

5. Both a and b should considered.

Answer 1

Qns 1

MIRR is the discount rate that equates the PV of outflows with the FV of the cash inflows. - True

Modified Internal rate of return is the return that equates the PV of outflows with FV of cash inflows and reflects the cost and profitability of the projects more accurately than IRR.

In simple terms, if we write the equation: (1+MIRR)^n * (PV of cash outflow) = FV of cash inflow

NPV is based on the assumption that a project’s cash flow is reinvested at IRR. - False

The net present value method does not have any assumption for the reinvestment rate. But the said statement is an assumption followed in the IRR method. IRR method assumes that the cash flows are reinvested at the IRR rate again.

NPV profile is a downward sloping line and identifies the relationship between NPV and IRR.- False

NPV profile is a graph between NPV and discount rate but not between NPV and IRR.

Scale difference and timing differences are two reasons lead to NPV profiles cross-over. - True

There are 2 reasons for NPV profiles to cross-over - Either the cost of projects are different or the timing of the cash flows is different.

Qns 2: Option B is correct

Interest expense will only be included while calculating Free cash flow(FCF) from the given option.

A sunk cost is the cost already incurred, that's why we don't use it to calculate future cash flow. Opportunity cost is also the cost/loss of the selection of alternative projects in place of others. And they are also not a part of future cash flow statements. That's why only the interest expense of debt financing is the correct answer.