Question

Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

Group of answer choices
A) If a project's IRR is positive, then its NPV must also be positive.
B) A project's IRR is the discount rate that causes the PV of the inflows to equal the project's cost.
C) If a project's IRR is smaller than the WACC, then its NPV will be positive.
D) A project's regular IRR is found by compounding the cash inflows at the WACC to find the present value (PV), then discounting the TV to find the IRR.

Answer 1

The correct answer is B) A project's IRR is the discount rate that causes the PV of the inflows to equal the project's cost. Other statements provided are incorrect because they contain fundamental misunderstandings of financial concepts such as the IRR and NPV.

Step-by-step explanation:

The correct statement among the options provided is B) A project's IRR is the discount rate that causes the PV of the inflows to equal the project's cost. This is because the internal rate of return (IRR) is specifically defined as the discount rate at which the net present value (NPV) of a project's cash flows (both inflows and outflows) is zero. This implies that the present value of the cash inflows at the IRR equals the initial project cost.

In contrast, statement A is incorrect because an IRR being positive does not necessarily mean the NPV is also positive; it depends on the comparison with the cost of capital. Statement C is incorrect because if IRR is smaller than the weighted average cost of capital (WACC), this indicates a negative NPV. Statement D is incorrect in its description of finding the IRR; the IRR is not found through compounding at the WACC.

In the context of financial investments, varying rates of return and risk levels significantly influence investment decisions. Investors tend to move their capital from riskier or lower-return investments to those perceived as safer or offering higher returns. This decision-making process affects the supply curves of financial capital for different investment opportunities.