Question

CH 22 If the internal rates of return of two mutually exclusive investments exceed the firm's cost of capital, the firm should

A make the investment with the lower internal rate of return

B make neither investment

C make both investments

D make the investment with the higher internal rate of return

Answer 1

The Correct answer is D - make investment with the higher internal rate of return

• Mutually exclusive investments means that out of the two investments we can select only one of them.
• The Internal rate of rate of return is the discount rate that will make the net present value equal to 0.
• When the Internal rate of return will be equal to or exceed the firm's cost of capital then such project should be accepted or such investment should be made. Cost of capital can be defined as the minimum acceptable return from a project or investment.
• In case of mutually exclusive investments we will have to select only that investment whose internal rate will be higher.

Therefore it can be concluded that if the internal rate of return of two mutually exclusive investments exceed the firm's cost of capital, the firm should make the investment with the higher internal rate of return.