NPV provides the correct signal for choosing among mutually exclusive investments. It also measures the impact that competing projects have on the value of the firm. Choosing the project with the largest NPV is consistent with maximizing the wealth of shareholders. While IRR does not consistently result in choices that maximizes wealth because it cannot, by nature, consider the absolute amount of contributions of projects.

Cost of capital is 12%

Exercise:

Data on 2 projects follow:

For Project A:

- Annual revenues of 240,000

- Annual operating costs of 120,000

- Investment of 360,000

- Life of 5 years

For Project B:

- Annual revenues of 300,000

- Annual operating costs of 160,000

- Investment of 420,000

- Life of 5 years

1. Calculate both projects' NPV.

2. Calculate both projects' IRR.

3. Which project should be chosen?