Question

Lancaster Corp. is considering two equally risky, mutually exclusive projects, both of which have normal cash flows. Project A has an IRR of 11%, while Project B's IRR is 14%. When the cost of capital is 8%, the projects have the same NPV. Given this information, which of the following statements is CORRECT?a. If the cost of capital is 9%, Project A's NPV will be higher than Project B's.b. If the cost of capital is 6%, Project B's NPV will be higher than Project A's.c. If the cost of capital is greater than 14%, Project A's IRR will exceed Project B's.d. If the cost of capital is 9%, Project B's NPV will be higher than Project A's.e. If the cost of capital is 13%, Project A's NPV will be higher than Project B's.

Answer 1

Answer:

Explanation:

IRR is the discount rate point where NPV equal to 0. Given, both projects have same NPV at 8%, when discount rate is higher than 8%, NPV of project A will decrease faster than that of project B because project A's IRR is lower than project B's IRR. When discount rate is lower than 8%, NPV of project A will increase faster than project B's.

We will go through each of the answer options:

A. If the cost of capital is 9%, Project A's NPV will be higher than Project B's. False

Explaination: Cost of capital here is higher than 8%, NPV of project A will be lower than that of project B.

B. If the cost of capital is 6%, Project B's NPV will be higher than Project A's. False

Explaination:

C. If the cost of capital is greater than 14%, Project A's IRR will exceed Project B's. False

Explaination: IRR is dependent on pattern of cashflows rather than cost of capital.

D. If the cost of capital is 9%, Project B's NPV will be higher than Project A's. True

Explaination: This is an opposite answer to option A.

E. If the cost of capital is 13%, Project A's NPV will be higher than Project B's. False

Explaination: When the cost of capital is 13%, NPV of project A is negative and NPV of project B is positive.