Question

You are a financial analyst for Green Country Products, Inc. You are evaluating two different capital budgeting proposals. However, because the proposals are mutually exclusive, Green Country can only accept one of them. You must determine which of the proposals is better and should be adopted. The following table provides Green Country’s cost of capital (i.e., discount rate), net present value (NPV), and internal rate of return (IRR) for the two proposals. Which proposal should be selected?

	Project A	Project B
NPV	$ 1.85 million	$ 2.25 million
IRR	18.0%	16.5%
Discount Rate	14.0%	14.0%

Group of answer choices

Choose Project B because it has the greater NPV.

Choose Project A because it has the greater IRR.

None of these are correct.

Calculate the profitability index (PI) and choose the project that is favored by two of the decision criteria (i.e., best two out of three)

Answer 1

Although NPV method reign supreme when there are conflicting results between various approaches,so the project with the greater NPV should be selected. However, we can say anything till we know that both the projects have same lives. If that is not the case, then the NPV needs to be found using the replacement chain LCM method or the EAA method, both will result in the same answer.

We cant always trust IRR approaches because if the CFs are unconventional then there can be several IRRs or no IRR at all. Therefore without knowing more about the CFs we should not come to a conclusion

NPV PI = 1+ Initial outlay

PI Calculation can't be completed till we get the figure of initial outlay for both the projects

As PI is directly related to NPV, so the project with a higher NPV will always have a higher PI. So if we go for best of 2 criteria then Project B is better even if it has a lower IRR, However, without knowing that they are of the same lives we should choose the option which says non of these choices is correct.