Question
As the CFO of Diggin Corporation, you believe that the investment decision on a project should be based on its NPV, that is, to accept
As the CFO of Diggin Corporation, you believe that the investment decision on a project should be based on its NPV, that is, to accept a project if its NPV is positive. However, the president of Diggin insists that no project should be accepted unless its IRR exceeds the projects risk-adjusted WACC. Suppose the firm is evaluating a project whose initial cost is $15,000. The project is forecasted to generate $110,000 cash inflow at the end of year 1 and -$100,000 cash outflow at the end of year 2. The WACC of this project is 10%, at which the NPV is $2,355.37. But you find two IRRs for this project: 6.33% and 527%. Which of the following statements best describes your optimal recommendation, i.e., the analysis and recommendation that is best for the firm and least likely to get you in trouble with the president?
A. You should recommend that the project be rejected because, although its NPV is positive, it has an IRR that is less than the WACC.
B. You should recommend that the project be rejected because (1) its NPV is positive and (2) it has two IRRs, one of which is less than the WACC, which indicates that the firms value will decline if the project is accepted.
C. You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC.
D. You should recommend that the project be accepted because its NPV is positive. You should explain this to the president and tell him that the firms value will increase if the project is accepted.
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