Question
Understanding the NPV profile If mutually exclusive projects with normal cash flows are being analyzed, the net present value (NPV) and internal rate of return
Understanding the NPV profile
If mutually exclusive projects with normal cash flows are being analyzed, the net present value (NPV) and internal rate of return (IRR) methods (never, sometimes or always) agree.
Projects Y and Z are mutually exclusive projects. Their cash flows and NPV profiles are shown as follows.
Year | Project Y | Project Z |
---|---|---|
0 | $1,500 | $1,500 |
1 | $200 | $900 |
2 | $400 | $600 |
3 | $600 | $300 |
4 | $1,000 | $200 |
If the weighted average cost of capital (WACC) for each project is 6%, do the NPV and IRR methods agree or conflict?
The methods agree.
The methods conflict.
A key to resolving this conflict is the assumed reinvestment rate. The IRR calculation assumes that intermediate cash flows are reinvested at the (modified internal rate of return (MIRR), internal rate of return (IRR) or required rate of return) , and the NPV calculation implicitly assumes that the rate at which cash flows can be reinvested is the required rate of return, internal rate of return (irr) or modified internal rate of return (MIRR)?
As a result, when evaluating mutually exclusive projects, the (IRR Method or NPV method) is usually the better decision criterion.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started