Next, we considered the specifi c problems with the NPV for mutually exclusive projects. We showed that, due to differences in either size or timing, the project with the highest IRR need not have the highest NPV. Hence, the IRR rule should not be applied. (Of course, NPV can still be applied.)

However, we then calculated incremental cash fl ows. For ease of calculation, we suggested subtracting the cash fl ows of the smaller project from the cash fl ows of the larger project. In that way the incremental initial cash fl ow is negative. One can always reach a correct decision by accepting the larger project if the incremental IRR is greater than the discount rate. LO.1