Question

Project Brady and Project Grey are two mutually exclusive projects with equal risk that are competing to use the same finite resource of limited-edition hotstoppers, which are reusable plastic sticks designed to stop hot coffee spilling from your takeaway coffee cup. Both projects commence with an initial up-front cash inflow followed in future years by a series of annual cash outflows. Both projects have positive internal rates of return (IRR) and both projects share the same positive net present value (NPV) when the discount rate is exactly 19% per annum. Project Brady has a lower IRR than Project Grey.

Which of the following statements is correct?

(No answer given)

At any positive discount rate below 19% p.a., Grey should be accepted and Brady should be rejected.

At any positive discount rate above 19% p.a., Brady should be accepted and Grey should be rejected.

At any positive discount rate below 19% p.a., Brady should be accepted and Grey should be rejected.

At any positive discount rate above 19% p.a., Grey should be accepted and Brady should be rejected.

More than one of the above answers are correct.

Answer 1

Relation between IRR and Discount rate is very dramatic. IRR is the rate at which NPV of project became Zero. And discount rate is the expected rate of return of project.

If we see in this question it is given that Brady has lower IRR than Grey. So, we assumed that IRR of Brady 19.5% and Grey 20%.

So if you increase discount rate it will be much closer to 19.5% first, which will reduce the NPV of Project Braddy faster than Project Grey. So at this point Project Braddy should be rejected and Grey should be accepted.

Second option is totally wrong if first is right.

Option C is also correct, as if discount rate falls below 19% then gap between IRR or Project grey and discount rate will be much wider than Project Braddy. So Project Grey should be accepted and grey rejected.

So at the end , we can say Option A and Option C are correct. More than one options are correct.