Question

sparta corp. has a prospective project with an irr of 7.25%. its cost of preferred equity, cost of common equity, and post-tax cost of debt are 7%, 9%, and 4%, respectively, and sparta raises equal amounts of funding from all these three sources. choose the best statement:

A- the project’s required rate of return must be greater than 7.25%.

B- the project’s net present value (npv) must be $0.

C- the project’s npv must be negative.

D- the project’s npv must be positive.

E- there is insufficient information to assess either the required rate or the npv of the project.

Answer 1

The correct answer is option D ie. - the project’s npv must be positive.

A- the project’s required rate of return must be greater than 7.25%. - Incorrect

The required rate of return is the weighed average cost of capital which is 6.67%

Particulars	Weight	Cost	Weight x Cost
Debt/Bonds	33.33%	4.00%	1.33%
Preffered stock	33.33%	7.00%	2.33%
Common stock	33.33%	9.00%	3.00%
Cost of capital			6.67%

Thus statement A is incorrect.

B- the project’s net present value (npv) must be $0. -Incorrect

Since, IRR is the rate at which NPV is zero, and required rate is 6.67% so NPV must be postive

C- the project’s npv must be negative.-Incorrect

Since, IRR is the rate at which NPV is zero, and required rate is 6.67% so NPV must be postive

D- the project’s npv must be positive.-Correct

Since, IRR is the rate at which NPV is zero, and required rate is 6.67% so NPV must be postive

E- there is insufficient information to assess either the required rate or the npv of the project.-Incorrect

Since, IRR is the rate at which NPV is zero, and required rate is 6.67% so NPV must be postive

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