Capital Budgeting – NPV

Practice Question

Intro to Finance
Capital Budgeting
NPV
MCQs

When the cost of capital is less than IRR for two independent projects, then: (Assume both projects have conventional cash-flows, i.e., one cash outflow at time zero followed by a series of cash inflows)

A) The NPV and IRR methods will always result in the same accept and reject decisions.
B) The project with the highest equivalent NPV should be chosen.
C) The project with the highest IRR should be chosen.
D) The project with the highest PI should be chosen.
E) All of the above.

Answer +
Final Answer: A) The NPV and IRR methods will always result in the same accept and reject decisions.
Explanation +

Key Concepts:

  • NPV (Net Present Value): Present value of inflows minus outflows.
  • IRR (Internal Rate of Return): Discount rate that makes NPV = 0.
  • Cost of Capital: Required return for investment viability.

Logic:

  • For projects with conventional cash flows (initial outflow followed by inflows), a cost of capital < IRR means NPV > 0.
  • So, both NPV and IRR methods will agree on acceptance/rejection of such projects.

Conclusion: Since both projects are independent and have conventional cash flows, and the cost of capital is less than IRR for both, both methods lead to the same decision. Hence, the correct answer is A.