Question
6. Understanding the NPV profile If projects are mutually exclusive, only one project can be chosen. The internal rate of return (IRR) and the net
6. Understanding the NPV profile
If projects are mutually exclusive, only one project can be chosen. The internal rate of return (IRR) and the net present value (NPV) methods will not always choose the same project. If the crossover rate on the NPV profile is below the horizontal axis, the methods will agree.
Projects W and X are mutually exclusive projects. Their cash flows and NPV profiles are shown as follows.
Year | Project W | Project X |
---|---|---|
0 | $1,000 | $1,500 |
1 | $200 | $350 |
2 | $350 | $500 |
3 | $400 | $600 |
4 | $600 | $750 |
If the weighted average cost of capital (WACC) for each project is 10%, do the NPV and IRR methods agree or conflict?
The methods conflict.
The methods agree.
A key to resolving this conflict is the assumed reinvestment rate. The NPV calculation implicitly assumes that intermediate cash flows are reinvested at the , and the IRR calculation assumes that the rate at which cash flows can be reinvested is the .
As a result, when evaluating mutually exclusive projects, the is usually the better decision criterion.
Grade It Now
Save & Continue
Continue without saving
Step by Step Solution
There are 3 Steps involved in it
Step: 1
![blur-text-image](https://dsd5zvtm8ll6.cloudfront.net/includes/images/document_product_info/blur-text-image.webp)
Get Instant Access with AI-Powered Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
![blur-text-image](https://dsd5zvtm8ll6.cloudfront.net/includes/images/document_product_info/blur-subtext-image.webp)
Step: 3
![blur-text-image](https://dsd5zvtm8ll6.cloudfront.net/includes/images/document_product_info/blur-subtext-image.webp)
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started