Question

Consider the following two mutually exclusive projects:

Year	Cash Flow (A)	Cash Flow (B)
0	-$300,000	-$40,000
1	20,000	19,000
2	50,000	12,000
3	50,000	18,000
4	390,000	10,500

Whichever project you choose, if any, you require a 15 percent return on your investment.

a) If you apply the NPV criterion, which investment will you choose? Why?

b) If you apply the IRR criterion, which investment will you choose? Why?

c) Based on your answers in (a) through (b), which project will you finally choose? Why?

Answer 1

Mutually exclusive projects are a set of projects out of which only one project can be selected

Part a:
NPV of project A is =$11058.07
NPV of project B is =$3434.16
If we apply NPV criterion, we would select the project with higher NPV that is $11058.07 or project A

Part b:
IRR of project A is =16.20%
IRR of project B is =19.50%
If we apply IRR criterion, we would select the project with higher IRR that is 19.50% or project B

Part c:
We would choose the project with higher NPV (that is project A) because higher NPV will increase the shareholders' equity by higher greater amount. Hence, project A should be selected.