You are reviewing two new projects: A and B. Both have conventional cash flows.

Question

You are reviewing two new projects: A and B. Both have conventional cash flows. They will compete for the same resources so you can choose at most one of them. You require an annual return of 10% for project A. Project B is riskier so you require a higher return, 13% per year. The IRR of project A is 11% and the IRR of project B is 18%. Project A requires an investment of $440 and project B requires $552. The net present value of project A is $301 while the net present value of project B is $291. Assume you have sufficient findings to invest. a. If you apply the NPV rule, will you choose project A. project B. or both, or neither of them? b. If you apply the IRR rule, will you choose project A. project B. or both. or neither of them? c. Which investment criterion (NPV rule or IRR rule) is more appropriate in this case? State your reason(s).

Explanation / Answer

Answer:

a. NPV of both Project is positive, Hence as per NPV evaluation, we can accept both projects.

b. IRR of both projects are more than their required rate of returns (Project A IRR is 11% and its Required rate is 10% , Project B IRR is 18% and its required rate is 13%( , hence as per IRR evaluation both projects can be accepted.

c. IRR assumes reinvestment of intermediary cash flows on IRR only, hence NPV is the best method to evaluate the projects.

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