Question

A company takes on a project that has an IRR of 10% which is the same as its cost of capital. Is this a good decision?

a. No. Only projects with positive NPV’s should be accepted.

b. No. In such cases, the company should seek a vote from its shareholders before a decision to go ahead should be taken.

c. Depends on the payback period of the project.

d. Perhaps, depending on the situation. This project has an NPV of zero and though not increasing the wealth of the company it may place the company in a better strategic position in the business environment.

Answer 1

When IRR is equal to Cost of capital, it implies that NPV =0

It means that project earns exactly same amount as it has spent on projects. But it does not mean that it is not a good project. The project will not be accepted only if it has negative NPV. So correct answer = d

Payback period does not include all years cash flows and also does not take into account time value of money, so it is not used for determining the project should be accepted or not.

Managers are appointed for decision making of the projects by dierctors which are appointed by shareholders, so question of asking shareholders does not arise as they have appointed qualified people for the same.

so correct answer :  d. Perhaps, depending on the situation. This project has an NPV of zero and though not increasing the wealth of the company it may place the company in a better strategic position in the business environment. [Thumbs up please]