Tesar Chemicals is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates the NPV. If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone, i.e., what's the chosen NPV versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. NPV will have no effect on the value gained or lost.
A) $138.10
B) $149.21
C) $160.31
D) $171.42
E) $182.52

Question

Tesar Chemicals is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates the NPV. If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone, i.e., what's the chosen NPV versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. NPV will have no effect on the value gained or lost. 
A) $138.10 
B) $149.21 
C) $160.31 
D) $171.42 
E) $182.52

Quizplus · Accepted Answer

To determine the forgone value, we need to calculate the difference between the maximum possible NPV and the NPV of the project chosen based on IRR. We can see from the cash flow table that Project L has the higher NPV ($420.17), while Project S has the higher IRR (22.64%). If we choose Project S based on IRR, the NPV of the chosen project will be $282.07. Therefore, the forgone value is:

$420.17 - $282.07 = $138.10

So, by choosing the project with the higher IRR instead of the higher NPV, Tesar Chemicals will forego $138.10 in value.

Tesar Chemicals Is Considering Projects S and L, Whose Cash