Got another one: Ron’s Organic mkts has limited access to borrowed funds and must choose among several independent projects with returns greater than their cost of capital. All the projects under construction have the same required investment of $2 Million and Ron has $10 Million available for capital investments this yr. Which of the following selection criteria is least likely to produce the optimal five projects for investment? Chose the five projects with: A. the greatest total NPV B. The largest sum of profitability indexes C. the highest IRRs D. the greatest PV of total expected incremental after-tax cash flows. The answer is C. but is it C because even tho the projects are independent he would have to choose one over the other which would make the other ranking options more appealing?
I couldn’t understand,I think its should be A because it maximizes the shareholder wealth.
Agree with A
The question is “Which of the following selection criteria is least likely to produce the optimal five projects” A is probably the best measure - since all are NPV positive, the top 5 would be the 5 best to accept (even the 5th highest would be good). Is C the answer because IRR only gives you an answer of “accept” or “reject” for independent projects but not good for ranking? (i.e. if 10 were IRR positive, it would not be an easy decision) I don’t exactly understand how to calculate D but top 5 PV of after-tax CFs sound like a very good ranking of projects.
I got this one wrong at the time…having read the above, I suppose highest IRR doesn’t actually mean anything if they are below required rate of return, they could still not be high enough to make the project a viable concern.
Yea I don’t like this question. I thought for independent projects IRR and NPV were the 2 optimal ranking calc’s to use.