Question

About investment criteria. We have discussed about five investment criteria, including NPV, IRR, PI, AAR and Payback.

a) Given that three projects are mutually exclusive and their information is as follows, which project to choose and why?

	Project A	Project B	Project C
NPV	$500,000	$200,000	$300,000
IRR	12%	15%	18%
PI	1.5	2.0	1.6

b) Which two investment criteria do NOT take time value of money into the consideration?

c) List two exceptional cases that IRR is not reliable

Answer 1

ANSWER DOWN BELOW. FEEL FREE TO ASK ANY DOUBTS. THUMBS UP PLEASE.

a. The NPV and IRR can lead to a conflicting decision because

1. The distribution of cash flow in the projects. (Non- conventional cash flows).

2. The size of the project.

3. Nature of Project (Independent vs Mutually exclusive).

NPV absolute measure whereas IRR is a relative measure.

NPV gives absolute dollar returns.

IRR are reinvest the cash flow at IRR rate, which is not true and hence not a better technique.

IRR is not prefered for mutually exclusive projects.

Npv is a better technique then compared to the internal rate of return.

Mutually exclusive means only one out of the several projects(or sites) can be accepted.

Hence project with HIGHEST NPV IS CHOSEN.

Answer: Project A.

b. Payback period & Average Rate of Return.

c. The IRR can lead to a conflicting decision,(or not reliable), in these cases:

1. The distribution of cash flow in the projects. (Non- conventional cash flows).

2. Nature of Project (Independent vs Mutually exclusive).