Question

) Which if the statements below describes the correct capital budgeting decision rule? a) Reject a project if the cost of capital exceeds the IRR. B) Reject a project if the cost of capital is less that the NPV. C) Accept a project if the NPV is greater than the IRR. D) Accept a project if the cost of capital is greater that the NPV.

Answer 1

a) When the cost of capital exceeds the IRR, then the project should be rejected. The project should be accepted and pursued only when the IRR is greater than cost of capital.

b) When the cost of capital is less than the NPV, then the project should be accepted. NPV is calculated using the firm's cost of capital.

c) NPV is the preferred method in case of inconsistencies arise. It better reflects the primary goal of the company i.e. growth of financial wealth of company. Hence, the project with high NPV and less IRR will be selected.

d) If the cost of capital is greater than the NPV, then the project should be rejected.

The statements a and c are correct and support the correct capital budgeting decision rule.