Question

You are considering two mutually exclusive projects.

Project A has an IRR of 10%

Project B has an IRR of 8%

The crossover rate is 6%

Which project will have the greatest NPV if the Required Return is 4%

Group of answer choices

Project A and B would have the same NPV

There is not enough information to answer this question.

Project B

Project A

Answer 1

The use of IRR, as a criterion to accept capital investment decision involves a comparison of IRR with the required rate of return known as cut off rate. The project should the accepted if IRR is greater than cut-off rate. If IRR is equal to cut off rate the firm is indifferent. If IRR less than cut off rate the project is rejected. Thus,

  If IRR ≥ Cut-off Rate or WACC - Accept the Proposal

  If IRR ≤ Cut-off Rate or WACC - Reject the Proposal

According to the question, Project A's IRR (10%) is greater than cross-over rate (6%) i.e. 4% (10%-6%) more than cross-over rate & Project B's IRR (8%) is also greater than cross-over rate (6%) i.e 2% (8%-6%) which is marginally more than cross-over rate.Therefore, Project A's NPV will be higher as compare with Project B so that company should opt Project A.