CFA Practice Question

There are 233 practice questions for this study session.

CFA Practice Question

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%.

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.
Correct Answer: I, II and III

IRR calculation for a capital investment project assumes that all cash flows can be reinvested to earn exactly the IRR. If the cash flows are invested at a rate lower than the IRR, the realized return will be less than the IRR. If, however, the cash flows are invested at a rate higher than the IRR, the realized return will be greater than the 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.
You need to log in first to add your comment.