Assume that you are comparing two mutually exclusive projects. Which of the following statements...

Question:

Assume that you are comparing two mutually exclusive projects.

Which of the following statements is most correct?

a. The NPV and IRR rules will always lead to the same decision unless one or both of the projects are "non-normal" in the sense of having only one change of sign in the cash flow stream, i.e., one or more initial cash outflows (the investment) followed by a series of cash inflows.

b. If a conflict exists between the NPV and the IRR, the conflict can always be eliminated by dropping the IRR and replacing it with the MIRR.

c. There will be a meaningful (as opposed to irrelevant) conflict only if the projects' NPV profiles cross, and even then, only if the cost of capital is to the left of (or lower than) the discount rate at which the crossover occurs.

d. All of the above are true.

e. None of the above are true.

Capital Budgeting:

Capital Budgeting decisions employ several tools that help analysts make informed decisions. Sometimes these tools provide the same results while some times the results can be conflicting.

Answer and Explanation:

Assume that you are comparing two mutually exclusive projects. Which of the following statements is most correct?

a. The NPV and IRR rules will always lead to the same decision unless one or both of the projects are "non-normal" in the sense of having only one change of sign in the cash flow stream, i.e., one or more initial cash outflows (the investment) followed by a series of cash inflows.

NPV and IRR provide the same result for conventional cash flows. If there is more than one outflow, there can be a conflict as there is more than one IRR.


Let's analyze the other options:

b. If a conflict exists between NPV and IRR, the conflict can always be eliminated by dropping the IRR and replacing it with the MIRR. - Using MIRR is no guarantee that the conflict would be resolved.

c. There will be a meaningful (as opposed to irrelevant) conflict only if the projects' NPV profiles cross, and even then, only if the cost of capital is to the left of (or lower than) the discount rate at which the crossover occurs. - If NPV profiles cross, there can still be conflict irrespective of the crossing.


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Cost of Capital: Flotation Cost, NPV & Internal Equity

from Corporate Finance: Help & Review

Chapter 3 / Lesson 18
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