Question

You are analyzing two mutually exclusive projects.

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NPV ​ IRR

Project A​ $10,000​ 18%

Project B​ $18,100​ 13%

Which project do you recommend? Defend your answer as to why you recommended the particular project and specifically list what assumptions you used to justify the particular decision. In addition, what other factors should you consider when evaluating the above projects?

Answer 1

Project B with higher NPV would be recommended. When a project has a positive NPV , its IRR generally stays above the cut off required rate. The criterion of greater NPV is mostly considered over IRR because the ultimate objective of any company is increasing shareholders' wealth and the higher NPV of a project ensures that more positive cash flow will be generated from that project which will ensure greater value of the company.

Project A has a better IRR but IRR is the break-even rate at which NPV will be zero and of it is higher than cut off rate, the project is acceptable but it can be comparable with the advantage of higher NPV

So Project B is preferable.

Assumptions : We are assuming that the IRR of Project B is above cost of capital (which generally happens for positive NPV projects), the projects risks for each project has been incorporated in the discount factor , the project durations and cash flow patterns are similar .

Other factors of evaluation :

Various other factors that need to be considered while evaluating the projects are ;

1. The social and environmental impact of the projects

2. The synergies of the products and services offered by the projects with the existing portfolio of the company.

3. Any  technological risk of obsolescence of the products and services of the projects.