Question

In: Accounting

1.) If a project has an internal rate of return of 13% and a negative net...

1.) If a project has an internal rate of return of 13% and a negative net present value, which of the following statements is true regarding the discount rate used for the net present value computation?

a. The discount rate must have been greater than 13%.
b. The discount rate must have been equal to 13%.
c. The discount rate must have been less than 13%.

d. The discount rate must have been 0%.

2.) If a project's net present value is positive, the internal rate of return is:

a. less than the discount rate.
b. equal to the discount rate.
c. greater than the discount rate.

Solutions

Expert Solution

Internal Rate of Return (IRR) is the rate where Net Present Value (NPV) is Zero.

1. Based on the above statement we can conclude that, If a project has an internal rate of return of 13% and a negative net present value then discount rate is greater than IRR. Let us understand this by an example

Example :

Consider a situation in which by investing $ 9,000 in a year, we receive yearly payments of $ 2,500 each, plus $ 4,000 in the third year. By solving this we get a IRR of 11.2%

Year Cash Flow DCF @ 11.2% Present Value
0 (9000) 1.00 (9000)
1 2500 0.8933 2249
2 2500 0.8088 2022
3 2500 0.7273 1819
3 4000 0.7273 2910
NPV 0

Consider Discount rate as 12%, then the table will look as follows

Year Cash Flow DCF @ 12% Present Value
0 (9000) 1.00 (9000)
1 2500 0.8929 2232.14
2 2500 0.7972 1992.98
3 2500 0.7118 1779.45
3 4000 0.7118 2847.12
NPV (148.30)

So from the above data we can understand that when Discount rate is greater the IRR, NPV will be negative.

2. We can also conclude that when NPV is positive Discount rate is less than IRR


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