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e. The crossover rate, i.e., the rate at which Projects A and B have the
same NPV, is greater than either project’s IRR.
3. Suppose a firm relies exclusively on the payback method when
making capital budgeting decisions, and it sets a 4-year payback
regardless of economic conditions. Other things held constant, which of
the following statements is most likely to be true?
a. It will accept too many short-term projects and reject too many long-
term projects (as judged by the NPV).
b. It will accept too many long-term projects and reject too many short-
term projects (as judged by the NPV).
c. The firm will accept too many projects in all economic states because
a 4-year payback is too low.
d. The firm will accept too few projects in all economic states because a
4-year payback is too high.
e. If the 4-year payback results in accepting just the right set of projects
under average economic conditions, then this payback will result in too
few long-term projects when the economy is weak.
4. You are on the staff of Camden Inc. The CFO believes project
acceptance should be based on the NPV, but Steve Camden, 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