CFA CFA Level 1 Schweser EOC concept checkers reading 6

Schweser EOC concept checkers reading 6

  • This topic has 8 replies, 5 voices, and was last updated Apr-17 by lulu123.
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    • bendujamin
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      Hi all,

      in the schweser notes of reading 6 concept checkers the following question is mentioned:

      which of the following statements least accurately describes the IRR and NPV methods;

      A. The NPV tells how much the value of the firm has increased if you accept the project
      B. When evaluating indepedent projects, the IRR and NOV methods always yeild the same accept/reject decisions
      C. When selecting between mutually exclusive projects, the project with the highest NPV should be accepted regardless of the sign of the NPV calculation

      I though that answer B was the best as this is not allways the case, e.g. if the IRR project 1 < IRR project 2 but NPV project 1 > NPV project 2. But according to the book the correct answer is C?
      I see that negative NPV should be rejected, but imo B and C are both ‘least accurate’. Can someone explain why C is the correct answer?

      much appreciated!

      Benjamin

    • vincentt
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      B is correct. The keyword is “independent projects”.

      B would be wrong if its “mutually exclusive”. Especially when IRR and NPV indicate a contradicting decision, always go with NPV.

      If the NPV is negative that means your project isn’t making any or enough money to compensate the investor’s require rate of return which is your discount rate.

      For example, you took up a loan of $100k for a project and the rate of the loan is 10%, however your project is generating cash flows of $15k each year for 10 years. Your NPV would be -$7.8k, though it’s making money but it’s not enough to compensate the minimum or required rate. So only positive NPV should be accepted.

    • Sarah
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      I think the reason it is C is because there are times when IRR and NPV do yield the same result.

      While options given is C is always incorrect.

    • Sophie Macon
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      @bendujamin – B is correct. It’s only when evaluating mutually exclusive projects (i.e. either project A or B) that it may show conflicting results, mainly due to cash flow timing or project sizes differences.

    • lulu123
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      I agree with Diya

      I think that the “regardless of the sign” in choice C should jump as a totally false statement (it’s basically saying that if there are two projects, one +300 NPV, the other -50000 NPV, you would accept the latter because the absolute number is larger BUT IN REALITY YOU NEED POSITIVE NPV!!)

    • bendujamin
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      ok thanks all…its clear to me

    • Sarah
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      wait, what is the right answer? B or C?

      There is disagreement!

    • bendujamin
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      no right…c is the right answer….

    • lulu123
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      @diya

      C is the answer

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