Question

Two mutually exclusive projects each have a cost of $10,000. The total, undiscounted cash flows from Project L are $15,000, while the undiscounted cash flows from Project S total $13,000. Their NPV profiles cross at a discount rate of 10 percent. Which of the following statements best describes this situation? Please leave an explanation.  a. The NPV and IRR methods will select the same project if the cost of capital is greater than 10 percent; for example, 18 percent. b. The NPV and IRR methods will select the same project if the cost of capital is less than 10 percent; for example, 8 percent. c. To determine if a ranking conflict will occur between the two projects the cost of capital is needed as well as an additional piece of information. d. Project L should be selected at any cost of capital, because it has a higher IRR. e. Project S should be selected at any cost of capital, because it has a higher IRR.

Answer 1

The answer is

a. The NPV and IRR methods will select the same project if the cost of capital is greater than 10 percent; for example, 18 percent.

IRR is the rate at which NPV = 0

Higher the IRR, better it is

Since the NPV profiles cross at 10%, it means that the project with higher IRR will have lower NPV below 10%
Hence, Both IRR and NPV will produce same result if the cost of capital is greater than 10% (i.e. project with higher IRR)

However, the methods will conflict if the cost of capital is below 10%