Question

The table below lists the projects that your company is considering to invest:
Project   Payback Period (Years)   NPV (USD)   IRR (%)
A   4.7   53000   15.44
B   2.1   17000   17.76
C   4.7   18000   16.75
D   4.4   14000   17.05
E   2.8   14000   17.15
The required return is 14.6 percent. Which project should be accepted if they are mutually exclusive?
      
E
      
D
      
C
      
B
      
A

Answer 1

In case of mutually exclusive projects here, we have to pick only one project. Now, required return for the project is 14.6%, & IRR of every project is exceeding the required return. This means that we can go for the highest IRR project which is Project B with an IRR of 17.76%. But IRR means that the reinvestment is taking at the rate of IRR. Thus, it is not considered the best method for the project evaluation.

                                                                        In case of project payback period which is least in case of Project B ie 2.1 years, Time value of money is straightly ignored & it does not consider the cash flows after the recovery of the cash ouflows.

                     NPV method provides an idea of absolute return in the dollars. It also considers that the project is reinvesting at the rate of required rate of return which is 14.6% in this case. This is more practical as compared to the IRR approach which is considering reinvestment at the IRR.

That is why, Project A (last option) with highest NPV ie. $53,000 is the right answer.