Question

Consider the capital budgeting decision to be made with the following data about 2 competing projects. Project A has an NPV of -$12 500, and IRR of 3% and a payback period of 3 years. Project B has an NPV of -$12 000, but an IRR of 2% and a payback period of 2 years 10 months. Which project(s) would be chosen on an independent basis?

Select one:

a. Project A and Project B

b. Project B

c. Neither Project A nor Project B

d. Project A

Answer 1

Solution:-

Project whose Net present Value are greater than or equal to zero is selected. Net Present Value is a difference between Present Value of Cash inflow and Present Value of cash outflow over a period of time. NPV are used to analysis a project that is profitable or not. In Case of Independent Project, Accept those project which has NPV is greater than zero.

So, In the given Question both are Independent Project and Both NPV are negative so Both Project are rejected as NPV is less then zero.

IRR(Internal Rate of return) is a discount rate that brings the NPV of a particular project as Zero. The project has higher IRR is better to taken. It is the rate at which NPV of futures cash flows are equal to its Initial Investment.

Payback period is the time in which it takes to recover the initial cost of the project. Payback period is lower the better. It is length of time which project takes to reach its Break Even Point.

So, In the Given Question, the correct answer is point C i.e. Neither Project A nor Project B.

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