Question

Which of the following statements is​ FALSE?

A.If the cost of capital estimate is more than the​ IRR, the NPV will be positive.
B.The IRR can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital.
C.If you are unsure of your cost of capital​ estimate, it is important to determine how sensitive your analysis is to errors in this estimate.
D.In​ general, the difference between the cost of capital and the IRR is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision.

Answer 1

The false statement is that a cost of capital estimate higher than the IRR results in a positive NPV, when in fact it would result in a negative NPV.

Step-by-step explanation:

The statement that is FALSE among the given options is A: 'If the cost of capital estimate is more than the Internal Rate of Return (IRR), the Net Present Value (NPV) will be positive.' In reality, if the cost of capital is more than the IRR, the NPV will be negative, not positive. The NPV is calculated by discounting the future cash flows at the cost of capital, and if the discount rate (cost of capital) exceeds the IRR, it reduces the present value of cash flows to a point where the NPV turns negative.

The other statements are true as they point towards the importance of understanding the cost of capital. The IRR does indeed provide information on the sensitivity of an investment to errors in estimating the cost of capital (B), and it is crucial to understand how sensitive an investment is to these estimates (C). It is also true that the difference between the cost of capital and the IRR represents the buffer for estimation errors in the cost of capital that would change the investment decision (D).