Question

Which of the following statement(s) is correct?

Cash flows are conventional when there are no cash inflows prior to a cash outflow.
In terms of shareholder wealth maximization in the context of mutually exclusive projects, the project with the higher IRR is not necessarily better than the project with the lower IRR.
Financing matters for valuation, but is typically ignored in determining cash flows in capital budgeting.

a. All three are false

b. Only 1. is correct

c. All three are correct

d. Only 2. is correct

e. Only 1. and 3. are correct

Answer 1

All the three given options are true.

In conventional cash flow, initial cash outflow is followed by a series of cash inflows. So the first statement is true.

In case of mutually exclusive projects , NPV and IRR may show conflicting results specially when the size of the projects are different. In such case higher IRR may not lead to the higher NPV and shareholders 'wealth maximization (NPV) may not be co-related to IRR . So the second statement is true.

Valuation matters in valuation as the capital structure influences the valuation, however in determining cash flows for Capital Budgeting , financing aspect is ignored because the effect of financing is taken care by using the cost of capital as the discounting factor of cash flows. The addition of financing factor in cash flow will cause double count of financing impact. So the third statement is also true.

so, Answer c. All three are correct ---is the right option.