Question

If mutually exclusive projects with normal cash flows are being analyzed, the net present value (NPV) and internal rate of return (IRR) methods   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 14%, do the NPV and IRR methods agree or conflict?

The methods conflict.

The methods agree.

When there is a conflict, a key to resolving this it is the assumed reinvestment rate. The IRR calculation assumes that intermediate cash flows are reinvested at the _________ , and the NPV calculation implicitly assumes that the rate at which cash flows can be reinvested is the ___________ . Fill in the blank options: (IRR, MIRR, Required rate of return)

As a result, when evaluating mutually exclusive projects, the (NPV METHOD OR IRR METHOD) is usually the better decision criterion.

Answer 1

calc:

The IRR calculation assumes that intermediate cash flows are reinvested at the IRR(internal rate of return), and the NPV calculation implicitly assumes that the rate at which cash flows can be reinvested in the WACC

NPV METHOD is usually the better decision criteria.