Question

Choose a wrong statement regarding capital budgeting.

① For a business project with a negative net present value (NPV), its internal rate of

return (IRR) must be lower than the weighted average cost of capital (WACC)

used to evaluate the project.

② Because the NPV and IRR of mutually exclusive projects can give opposite results,

entirely depending on the IRR method to choose a business project can minimize

the risk of misjudgment.

③ The big difference between the NPV and IRR methods lies on the assumption

regarding the reinvestment of cash flows during the investment periods.

④ The IRR and NPV methods always give the same results for independent projects.

Answer 1

Wrong statement regarding capital budgeting is-

3) Because the NPV and IRR of mutually exclusive projects can give opposite results, entirely depending on the IRR method to choose a business project and minimise the risk of misjudgement.

For mutually exclusive projects if the NPV and IRR approach give opposite results we should always select the NPV approach. NPV approach correctly discount the future cash flows to their present value and by detecting the initial investment and calculating the net present value of the project. The IRR approach completely ignores the size and the duration of the project. Hence, the NPV method is considered to be a suitable selection in case of a conflict between the two methods.

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