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Two projects are being considered. An office building has an IRR of 20%; NPV of $100,000...

Two projects are being considered. An office building has an IRR of 20%; NPV of $100,000 and a payback of 3 years. Alternatively a small sandwich shop has an IRR of 40%; NPV of $25,000 and a payback of 1 year. Which of the two projects should be chosen?

If projects are mutually exclusive, choose both; if projects are independent, choose Sandwich shop.

If projects are mutually exclusive, choose Sandwich Shop; if projects are independent, choose both.

Do not choose any of the projects under any circumstances.

If projects are mutually exclusive, choose both; if projects are independent, choose Office Building.

If projects are mutually exclusive, choose Office building; if projects are independent, choose both.
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Answer #1

Answer: Correct answer is "if projects are mutually exclusive, choose Office building; if projects are independent, choose both".

We give first priority to NPV when choosing projects because positive NPV will increase the shareholder's value.
Here, both the projects have positive NPV, so both can be selected if they are independent projects.
In case of independent projects all the projects meeting the capital budgeting criterion should be accepted.
Mutually exclusive projects are a set of projects, out of which we can select only one project. So, we select the project with higher NPV.
So, in this case we need to select the office building project if the given projects are mutually exclusive.

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