Two mutually exclusive projects have the following expected cash flows, net present values, and internal rates of return: If the appropriate discount rate is 15%, which project should be undertaken and why?
A)Project B since its initial investment is returned in the first year and can then be invested in another project
B)Project B since its IRR is higher than that of Project A
C)Project A since it has the higher net present value of the two projects
D)Project B since its total cash inflows are more than twice the cost of the project, whereas Project A's cash inflows are just twice the initial investment.

Question

Two mutually exclusive projects have the following expected cash flows, net present values, and internal rates of return:  If the appropriate discount rate is 15%, which project should be undertaken and why?
A)Project B since its initial investment is returned in the first year and can then be invested in another project 
B)Project B since its IRR is higher than that of Project A 
C)Project A since it has the higher net present value of the two projects 
D)Project B since its total cash inflows are more than twice the cost of the project, whereas Project A's cash inflows are just twice the initial investment.

Quizplus · Accepted Answer

The best choice would be Project A since it has the higher net present value of the two projects at a discount rate of 15%. The NPV for Project A is $1,665, whereas the NPV for Project B is only $1,217. The fact that Project B's initial investment is returned in the first year and has a higher IRR are certainly favorable factors, but at a 15% discount rate, the higher net present value of Project A takes precedence. When choosing between two mutually exclusive projects, the project with the higher net present value should be selected. Project A has a higher net present value of $13,325 compared to Project B's $4,027 at a 15% discount rate. While Project B has a higher internal rate of return, it does not take into account the varying scale of the projects and does not consider the time value of money. Initial investment and total cash inflows are also not reliable indicators of project profitability. Therefore, Project A should be undertaken as it generates a higher positive net present value.

Two Mutually Exclusive Projects Have the Following Expected Cash Flows