Consider projects S and L.Both have normal cash flows, and the projects have the same risk, hence both are evaluated with the same cost of capital, 10%.However, S has a higher IRR than L.Which of the following statements is CORRECT?
A) If Project S has a positive NPV, Project L must also have a positive NPV.
B) If the cost of capital falls, each project's IRR will increase.
C) If the cost of capital increases, each project's IRR will decrease.
D) If Projects S and L have the same NPV at the current cost of capital, 10%, then Project L, the one with the lower IRR, would have a higher NPV if the cost of capital used to evaluate the projects declined.
E) Project S must have a higher NPV than Project L.

Question

Quizplus · Accepted Answer

D is correct because if two projects have the same NPV at a certain cost of capital, the project with the lower IRR (Project L in this case) will benefit more from a decrease in the cost of capital. This is because the NPV increases as the discount rate (cost of capital) decreases, and the project with the lower IRR starts with a higher discount rate relative to its IRR, thus it has more room to gain in NPV from a decrease in the cost of capital.

Consider Projects S and L