Question: Should the company accept a project that has an IRR of 14% and an NPV of $2.8m if the cost of capital is 12%
A. Yes, based only on the NPV B. Yes, based on the NPV and the IRR
C. No, based on both the NPV and the IRR
I selected A because I think if NPV>0, then apparrently, IRR will be larger than cost of capital. But the answer by Kaplan is B. I do not understand the rational behind. Could somebody kind enough to explain?
the npv can be positive and IRR be less than cost of capital… in this example… IRR > cost of capital
depends on timiming of cash flow
NPV>0: 1x good
IRR>Cost of Capital --> 2x good
2x good is better than 1x good.
B is the right answer.
Both NPV and IRR can be used to evaluate any projects, however descion based only on IRR would give misleading conclusion. so we would use NPV always FIRST if there is a choice between NPV and IRR.
IRR would differ if the timing and size of cash flow differ between two projects (multually exclusive projects), in this case the prefered method is NPV.
If the project is independent then NPV and IRR both gives you the same result. If NPV is positive, then IRR would be more than cost of capital, if NPV is negative then IRR would be less than cost of capital.
On this question, we assume that the project is independt as no other information is provided. As NPV and IRR would give the same result , the answer would be B.
Hope this helps