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CFA Level I · CFA Level I Exam · Capital Investments and Capital Allocation

A project requires an outlay of 50,000 today and produces a single cash inflow of 66,550 at the end of Year 3. The company's cost of capital is 12%. Which of the following is most accurate?

The IRR is 10% and the project should be rejected. Solving (1+r)^3 = 66,550/50,000 = 1.331 gives r = 10%, which is below the 12% cost of capital, so NPV is negative at about -2,632.

  1. AThe IRR is 10% and the project should be rejectedCorrect
  2. BThe IRR is 10% and the project should be accepted
  3. CThe IRR is 33% and the project should be accepted

Explanation

IRR solves 50,000 x (1+r)^3 = 66,550, so (1+r)^3 = 1.331 and r = 10%. Because 10% is below the 12% cost of capital, NPV = 66,550/1.404928 - 50,000 = 47,368 - 50,000 = -2,632, so reject. The 33% answer ignores compounding over three years.

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