Corp finance: Reading 29: Page 79, q26

CFA Level II
#1

Corp finance: Reading 29: Page 79, q26 I don’t really get the answer. by the way, what does “conventional cash flow paterns” mean? does the question try to ask about the difference between IRR and NPV? Thanks.

#2
  1. “conventional cash flow patterns” means the sign changes from negative to positive (or positive to negative) only once (one initial outflow and all the rest inflows). You can’t use IRR otherwise. Also, I believe the questions asks: for example, if you have 2 projects, both w/positive NPVs and positive IRRs, (not multiple IRRs) Pick the one with the highest NPV, even if the other project has a higher IRR. E.g., a $100 investment that returns $150 has $50 NPV and a 50% IRR and a $1000 investment that returns $1,100 has a $100 NPV and a 10% IRR. You should choose the $1000 project b/c it maximizes wealth, even though the IRR is higher in the other one. (There are other examples in the book that might better explain this.) 2) does the question try to ask about the difference between IRR and NPV? Yes. Notice statement C says if the projects have the “same initial outlay”… use either NPV or IRR b/c for example: a 10% return (IRR) is the same as NPV of 100 grand for a $1 Million dollar project. I hope that helps.
#3

really helps. Thanks! joec4256 Wrote: ------------------------------------------------------- > 1) “conventional cash flow patterns” means the > sign changes from negative to positive (or > positive to negative) only once (one initial > outflow and all the rest inflows). You can’t use > IRR otherwise. Also, I believe the questions > asks: for example, if you have 2 projects, both > w/positive NPVs and positive IRRs, (not multiple > IRRs) Pick the one with the highest NPV, even if > the other project has a higher IRR. E.g., a $100 > investment that returns $150 has $50 NPV and a 50% > IRR and a $1000 investment that returns $1,100 has > a $100 NPV and a 10% IRR. You should choose the > $1000 project b/c it maximizes wealth, even though > the IRR is higher in the other one. (There are > other examples in the book that might better > explain this.) > > 2) does the question try to ask about the > difference between IRR and NPV? Yes. Notice > statement C says if the projects have the “same > initial outlay”… use either NPV or IRR b/c for > example: a 10% return (IRR) is the same as NPV of > 100 grand for a $1 Million dollar project. > I hope that helps.