CFA® Level 1: CFA® Level 1

Which of the following statements is correct?

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A. To find a firm's marginal cost of capital for capital budgeting purposes, we would develop an MCC and an IOS schedule, find the WACC at the intersection of the two curves, and define that WACC to be the corporate cost of capital. However, this procedure will not lead to a meaningful answer if the firm uses debt.

B. If a project has only costs (no revenues) as would certain environmental projects, then the project is likely to have two regular IRRs but only one MIRR.

C. In general, the PVs of riskier cash flows should be found using relatively high discount rates. However, if a cash flow is non-normal (cash inflows followed by cash outflows, a lower discount rate should be used to evaluate risky projects.

D. It is better to use the NPV method to evaluate independent projects, but for mutually exclusive projects, especially if projects vary greatly in size, the MIRR method is better.

E. Firms A and B have identical balance sheets and income statements, pay the same rate of interest, have the same cost of retained earnings, k(s), and have the same very good set of investment opportunities. However, Firm A pays out only 20 percent of its earnings versus an 80 percent payout for Firm B. Firm A will probably have the higher marginal cost of capital schedule.

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A. B. C. D. E.

The other statements are incorrect because of the following: A project that has only costs has no IRR. The WACC incorporates the cost of all capital: debt, preferred stock, and equity. The NPV method is best used to evaluate mutually exclusive projects of varying size because the MIRR method may produce a conflicting result from the NPV in this situation. Firm B will have the higher cost of capital because it has the higher payout forcing it to go to more costly equity capital before Firm A.

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