Question

For mutually exclusive projects, the incremental IRR approach to capital budgeting reconciles the IRR and NPV methods because this approach overcomes the problems associated with multiple IRRs or no IRRs.

true of false

Answer 1

Statement is True.

Because in case of Mutually exclusive projects.

IRR may mislead you.

For example:-

Project A - Initial Outflow 300 , Return in next year 150 , thus IRR = 50%

Project B - Initial Outflow 100000, return in next year 20000, thus IRR = 20%

Here IRR says Project A is better but actually if we the size of the Retuen that is NPV , Project B would better.

Thus Incremental IRR fills the gap between NPV and IRR

as it considers Incremenatl Return and Incremental Initail Cash flow thus if Incremental IRR is more than Cost of Capital. One with incremental Return and Initial Cash flow should be selected.

Happy Learning!