You are on the staff of O'Hara Inc.The CFO believes project acceptance should be based on the NPV,but Andrew O'Hara,the president,insists that no project should be accepted unless its IRR exceeds the project's risk-adjusted WACC.Now you must make a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000 at the end of Year 1 and −$100,000 at the end of Year 2.The president and the CFO both agree that the appropriate WACC for this project is 10%.At 10%,the NPV is $2,355.37,but you find two IRRs,one at 6.33% and one at 527%,and a MIRR of 11.32%.Which of the following statements best describes your optimal recommendation,i.e.,the analysis and recommendation that is best for the company and least likely to get you in trouble with either the
CFO or 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 accepted because (1) its NPV is positive and (2) although it has two IRRs, in this case it would be better to focus on the MIRR, which exceeds the WACC. You should explain this to the president and tell him that the firm's value will increase if the project is accepted.
C)You should recommend that the project be rejected. Although its NPV is positive it has two IRRs, one of which is less than the WACC, which indicates that the firm's value will decline if the project is accepted.
D)You should recommend that the project be rejected because, although its NPV is positive, its MIRR is less than the WACC, and that indicates that the firm's value will decline if it is accepted.
E)You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC.

Question

You are on the staff of O'Hara Inc.The CFO believes project acceptance should be based on the NPV,but Andrew O'Hara,the president,insists that no project should be accepted unless its IRR exceeds the project's risk-adjusted WACC.Now you must make a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000 at the end of Year 1 and −$100,000 at the end of Year 2.The president and the CFO both agree that the appropriate WACC for this project is 10%.At 10%,the NPV is $2,355.37,but you find two IRRs,one at 6.33% and one at 527%,and a MIRR of 11.32%.Which of the following statements best describes your optimal recommendation,i.e.,the analysis and recommendation that is best for the company and least likely to get you in trouble with either the 
CFO or 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 accepted because (1) its NPV is positive and (2) although it has two IRRs, in this case it would be better to focus on the MIRR, which exceeds the WACC. You should explain this to the president and tell him that the firm's value will increase if the project is accepted.
C)You should recommend that the project be rejected. Although its NPV is positive it has two IRRs, one of which is less than the WACC, which indicates that the firm's value will decline if the project is accepted.
D)You should recommend that the project be rejected because, although its NPV is positive, its MIRR is less than the WACC, and that indicates that the firm's value will decline if it is accepted.
E)You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC.

Quizplus · Accepted Answer

The optimal recommendation is to accept the project because the NPV is positive and the MIRR exceeds the WACC. The fact that the project has two IRRs is not relevant in this case, and the focus should be on the MIRR, which takes into account the reinvestment rate assumption implicit in the project's cash flows. By accepting the project, the firm's value will increase, and this should be explained to the president to get his support. The CFO's preference for NPV as the basis for project acceptance should be respected but does not override the president's preference for IRR as the minimum hurdle rate.

You Are on the Staff of O'Hara Inc