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Basic Question 18 of 29
Company A is considering a capital investment project. The appropriate discount rate for the project is WACC = 5%. The project has the following NPV and IRR: NPV = $50,000, IRR = 6.5%.
II. If all cash flows for the project are reinvested to earn actually more than 6.5%, then the project's realized return will exceed its IRR.
III. If all cash flows for the project are reinvested to earn actually less than 6.5%, then the project's realized return will be less than its IRR.
Which of the following statements is (are) true?
I. If all cash flows for the project are reinvested to earn 6.5%, then the project's realized return will equal its IRR.
II. If all cash flows for the project are reinvested to earn actually more than 6.5%, then the project's realized return will exceed its IRR.
III. If all cash flows for the project are reinvested to earn actually less than 6.5%, then the project's realized return will be less than its IRR.
User Contributed Comments 5
| User | Comment |
|---|---|
| limpus | This assumes that there are more than 2 cash flows (one out at t=0 and one in at t=n). In this situation II and III should both read EQUAL rather than exceed and less than respectively. |
| surob | Limpus, per CFA book, it shouldn't be equal as you are suggesting. |
| ThanhBUI | CF reinvestment at IRR is the assumption for calculating IRR in the first place. |
| 95kalexand | correct surob .. that's an error on AN part, i believe |
| charliedba | IRR is the rate you calculate BEFORE the project starts. Yes that's the ASSUMED reinvestment rate. Then you have an actual realized rate, which is what happens. You can always compare the ASSUMED and ACTUAL reinvestment rate, and they are unequal in cases II and III. |
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Learning Outcome Statements
describe the capital allocation process, calculate net present value (NPV), internal rate of return (IRR), and return on invested capital (ROIC), and contrast their use in capital allocation
CFA® 2024 Level I Curriculum, Volume 2, Module 5.