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Homework answers / question archive / You attend an investment committee where your boss, the Chief Executive Office (CEO), and other executives meet to discuss capital budgeting
You attend an investment committee where your boss, the Chief Executive Office (CEO), and other executives meet to discuss capital budgeting. The investment committee reviews two projects that are mutually exclusive. The CEO notices that one project has a higher NPV and the other a higher IRR. The CEO wants your opinion on which project should be chosen: Project A Project B NPV +2,450,000 +1,230,000 IRR 9% 13% Neither project should be chosen because the discount rate (WACC) is likely higher than the IRRs. O NPV should be the deciding factor and project A should be chosen. IRR should be the deciding factor and project B should be chosen. Both projects should be chosen.
Comparing two mutually exclusive projects ,NPV and IRR may provide conflicting results.Project A has higher NPV whereas Project B has higher internal rate of return.This situation may occur beacuse of different cash flow patterns in two projects.In case of mutually exclusive projects firm needs to decide in one of the two projects to invest in.
Option B is correct ,NPV should be deciding factor and project A should be chosen.Project with higher NPV should be chosen because there is inherent reinvestment assumption.There is an assumption that the cash flows will be reinvested at same discount rate at which they are discounted.This makes NPV results superior to IRR results.
CEO should choose Project A
Option A is incorrect ,NPV is positive in both projects ,managemet should choose one of the projects having higher NPV
Option C is incorrect because project with higher NPV should be chosen due to inherent reinvestment assumption
Option D is incorrect beacuse in mutually exclusive projects ,we have to chose only one project and we cannot chose both projects.If the projects were independent in that case we can chose both the projects.
