Question

Consider the following two mutually exclusive projects.  Project A has an NPV of $0.5 billion, an IRR of 16% and a payback period of 4 years.  Project B has an NPV of $600 million, and IRR of 15% and a Payback period of 3 years. Which project should be chosen?

Answer 1

PROJECT A SHOULD BE CHOSEN because it has higher net present value and it has also higher internal rate of return so it is generating a higher amount of value addition to the company because it is having a higher amount of cash inflows in comparison to the cash outflows and it is also having a better internal rate of return.

We should not be considering payback period before net present value method for internal rate of return method because payback period does not consider the time value of money and time value of money is one of the most important concepts in decision making with regards to finance so we shall not be placing importance to the payback period.

Hence, Even though project B has a lower payback period but it has a lower net present value and internal rate of return which is most important, so we will select PROJECT A BECAUSE IT HAS BETTER NET PRESENT VALUE AND INTERNAL RATE OF RETURN.