Question at position 6 Xiong plc has recently undertaken net present value analysis on an investment opportunity. The discount rate, based on the cost of capital, was 12% and the net present value of the investment turned out to be negative £42,500. An accountant claims that this finding means that, if the internal rate of return method had been used to undertake the analysis, it would indicate that: The internal rate of return of the project is more than 12%. The investment opportunity should not go ahead. Are the above statements true or false?1) true, 2) falseBoth false1) false, 2) trueBoth trueClear my selection

Question

Question at position 6 Xiong plc has recently undertaken net present value analysis on an investment opportunity. The discount​ rate, based on the cost of capital, was​ 12% and the net present value of the investment turned out to be negative​ £42,500. An accountant claims that this finding means​ that, if the internal rate of return method had been used to undertake the​ analysis, it would indicate​ that: The internal rate of return of the project is more than 12%. The investment opportunity should not go ahead. Are the above statements true or​ false?1) true, 2) falseBoth false1) false, 2) trueBoth trueClear my selection

BlackTom AI · Accepted Answer

The question presents an NPV analysis at a discount rate equal to the cost of capital (12%), which yields a negative NPV of £42,500. We need to assess two statements in the context of the IRR method and decision rules.

Option 1: "The internal rate of return of the project is more than 12%." If the IRR were greater than the discount rate, the NPV at 12% would be positive, because IRR is the break-even discount rate that makes NPV zero. Since the actual NPV is negative at 12%, this implies the IRR must be below 12%, not above. Therefore, this statement is incorrect.

Option 2: "The investment opportunity should not go ahead." Since NPV at the cost of capital (12%) is negative, the project does not add value under the standard NPV rule, and the investment would be rejected. In IRR terms, IRR would be less than the required return (12%), reinforcing the decision not to proceed. Hence, this statement is correct.

Option 3: "1) true, 2) false" This would assert that the first statement is true and the second is false. We have determined the first statement is false and the second is true, so this combined option misrepresents both conclusions.

Option 4: "Both true" This asserts that both statements are true. Since the first statement is actually false, this option is also incorrect.

To recapitulate the logical flow: a negative NPV at the cost of capital signals IRR < 12%, which makes the assertion about IRR being greater than 12% invalid, while it supports the recommendation not to proceed, aligning with the second statement being true. The remaining composite options fail because they pair a false conclusion with a true or false claim that does not align with the underlying NPV/IRR relationship.

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