Cant figure out these finance questions??

Question

1. Which of the following would increase working capital?

A. cash used to buy marketable securities
B. cash dividend is declared and paid
C. missing inventory is written off against retained earnings
D. long-term bonds are retired from the proceeds of a preferred stock issue
E. merchandise is sold on credit, but at a profit

2. A project has an upfront cost of $100,000. The projects WACC is 12% and its net present value is $10,000. Which is most correct?

A. project should be accepted since its return is more than the WACC
B. the projects internal rate of return (IRR) is greater than 12%
C. the projects modified IRR (MIRR) is less than the IRR
D. all of the above

Answer 1

Working capital increases when inventory increases, A/R increases or A/P decreases.

For number two -- the key thing here is that it is a positive NPV project. That means that if you discount all future flows at the WACC, you get a positive number. This means its IRR is greater than the WACC. Therefore A and B are both true. I have never heard of a modified IRR (and I have a PhD from Berkeley and have taught corporate finance at MIT & Wharton). But since both A and B are ture, the only possible answer is D.

Answer 2

Answer to #1: E - When inventory is sold at a profit, its original cost is written down, but is more than offset by the higher accounts receivable increase.

Answer to #2: D - The IRR is the discount rate for a project with a zero NPV, so, by definition, the (NPV positive) project has a higher IRR than WACC, (Choice B) and should be accepted (Choice A)

In choice C's case, I assume that the questioner is assuming that cash flows would be reinvested at the WACC, not the IRR (which is greater than the WACC), so, by definition, the MIRR will be lower. It would be higher if we assume a reinvestment rate of greater than the IRR.

In response to the earlier poster, MIRR is a form of IRR that solves the "reinvestment paradox" which distorts the returns of very high and very low IRR projects. IRR assumes that cash flows are reinvested at the IRR. This is not always realistic, especially if the project is the highest yielding one in the portfolio. MIRR is calculated by investing each cash inflow at a predetermined rate (usually the WACC or the risk-free rate) instead of the IRR. The MIRR is the discount rate required to make this calculation NPV-neutral. Financial engineers use a form of MIRR to value bonds by reinvesting the future cash flows at the swap and/or LIBOR curve to account for this as well.