Question

You are considering the following two mutually exclusive projects. If the cost of capital for both projects is 7%, which statement concerning capital-budgeting rules listed will be correct in this situation?

Time

Year

0

Year

1

Year

2

Year

3

Project

A

-

$567

$300

$400

$300

Project

B

-

$296

$500

$100

$50

a)

Both NPV and IRR will choose the correct

project(s).

b)

Neither NPV nor IRR will choose the correct project(s).

c)

NPV will choose the correct project(s), IRR will not.

d)

IRR will choose the correct project(s), NPV will not.

Answer 1

IRR of project A is 34.56%
IRR of project B is 91.21%

NPV of project A is $307.64
NPV of project B is $299.45

As the IRR of both the projects are greater than the cost of capital they can be selected, however the one with higher IRR will be preferred.
As the NPV of both the projects are positive, both qualify to get selected, however the one with higher NPV will be preferred

Condition: Given that the two projects are mutually exclusive.
Mutually exclusive projects are the set of projects out of which only one project can be selected

In this case, we need to select the project with higher NPV, that is project A.
NPV decision rule is preferred as it directly increases the shareholders' value.

Hence, option c is correct