Which of the following statements regarding the net present value (NPV) and internal rate of return (IRR) is least accurate? A) The NPV tells how much the value of the firm will increase if you accept the project. B) For mutually exclusive projects, the internal rate of return IRR and the net present value NPV methods may give conflicting accept/reject decisions. C) For mutually exclusive projects, you must accept the project with the highest NPV regardless of the sign of the NPV calculation. D) For independent projects, the internal rate of return IRR and the NPV methods always yield the same accept/reject decisions.
hari, Is the answer C? You would never accept a project with a negative NPV. cheers
Thanks otaw - Yes, the correct answer is C. But what’s wrong with D, we do have conflicting results from two methods? Thanks.
As far as I know you should always consider NPV answer because sometimes IRR and NPV are contradicting
I looked it up and as a main dissadvantage for IRR it says that for mutually exclusive projects there are sometimes conflicting decisions with NPV method A is obviously correct B is corect because they are mutually exclusive D is corect because they are independent, both methods should have same result C is clearly untrue
“D) For independent projects, the internal rate of return IRR and the NPV methods always yield the same accept/reject decisions.” It doesn’t claim that it will give you the same results of one project over the other. All it says is that the accept/reject decision will be the same. That’s true; you can’t have a positive NPV for a project which you would reject on the basis of IRR.
You can certainly come up with a set of csh flows so the NPV is negative but the IRR is higher than the discount rate in your NPV calculations. If your accept reject/decision is based on IRR > fixed discount rate you could have different conclusions from NPV and IRR (I guess - I don’t really know what they’re getting at here either).
B&M state: When we compare the opp cost of capital with the IRR on our project, we are effectively asking whether our project has a positive NPV. This is true no only for our example. The rule will give the same answer as the NPV rule _whenever the NPV of a project is a smoothly declining function of the discount rate_. Joey, can you give an example of what you’re thinking?
^ only true if you don’t have to put capital into the project later.
Actually, I didn’t read the whole thing - “whenever the NPV of a project is a smoothly declining function of the discount rate” fixes it up. And of course that’s very useful because most of us can look at a series of cash flows and determine immediately that it is a declining function in the discount rate (yeah right). Here is an exmaple which I ripped off from someone else: year cash flow 0 -200 1-5 +195 6 -900 NPV at 0.05 discount rate = -27 IRR = 0.07 Edit: Note that if you make those +195’s into +200’s the IRR goes down to 0.055. So apparently, IRR says that you should choose the one where you get 195 in revenue instead of the 200 in revenue. Many of you probably have projects that could use an IRR boost. I am willing to help you locate such projects and increase their IRR by taking a portion of the revenue from the project. This will make you look very productive to your supervisors as you will have increased your firm’s IRR on some project.
don’t mean to jump back a few posts but just to clarify why some are getting confused - the questiona asks for “what is least accurate” - key word being “least”. Obviously, C is least accurate because it is never correct. I feel as though these types of questions with their tricky wording will come up numerous times throughout the test.
I guess. Suppose that you are a government regulated utility and the govt tells you that you need to put in a line to some thinly populated area. You can run it underground, on poles, or through outerspace. Then C) looks pretty correct to me.
touche