Question

"If a firm has no mutually exclusive projects but has only independent ones, and it also has both a constant required rate of return and projects with conventional cash flow patterns, then the NPV and IRR methods will always lead to identical capital budgeting decisions." Please state agree, disagree, or uncertain, and discuss your answer briefly.

Answer 1

In case of independent and not mutually exclusive projects, the firm has the option of undertaking all projects under consideration. This would imply that the firm is not constrained by capital rationing and hence free to pursue all projects subject to certain conditions being met. The condition of a conventional cash flow pattern (single initial outflow followed by regular inflows) and constant required rate of return would mean that the firm's NPV would be inversely related to the firm's required rate of return (discounting rate). This, in turn, would mean that any project which gives positive NPV would also give IRR higher than the firm's required rate of return, thereby reconciling the decision arrived at by the IRR and NPV criterion. Hence, one should agree with this statement.