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IAI Actuarial Core Principles · Business Finance · Cost of capital and evaluating investment projects

A project has an IRR of 14% and the firm's cost of capital is 11%. Which statement is correct for a conventional project with an initial outflow followed by inflows?

With a conventional cash flow pattern, NPV is zero at the IRR and positive at any lower discount rate. Since 11% is below the 14% IRR, the NPV is positive and the project adds value, so it should be accepted.

  1. AThe NPV at 11% is positive, so the project should be accepted on NPV groundsCorrect
  2. BThe NPV at 11% is negative because IRR exceeds the cost of capital
  3. CThe NPV at 14% is positive
  4. DThe project should be rejected because the IRR is above the hurdle rate
  5. The NPV is zero at 11%

Explanation

For a conventional project NPV falls as the discount rate rises and is zero at the IRR. At 11%, below the IRR of 14%, NPV is positive, so acceptance is supported. At 14% NPV is exactly zero.

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