If an independent project with conventional, or normal, cash flows is being anal
ID: 2766449 • Letter: I
Question
If an independent project with conventional, or normal, cash flows is being analyzed, the net present value (NPV) and internal rate of return (IRR) method agree. Projects W and X are mutually exclusive project flows and NPV profiles are shown as follows. If the weighted average cost of capital (WACC) for each project is 10%, do the NPV and IRR methods agree or conflict? The methods agree, the methods conflict. A key to resolving this conflict is the assumed reinvestment rate. The NPV calculation implicitly assumes that intermediate cash flows are reinvested at the, and the IRR calculation assumes that the rate at which cash flows can be reinvested is the. As a result, when evaluating mutually exclusive projects, the is usually the better decision criterion.Explanation / Answer
If an independent project with conventional, or normal cash flows is being analysed, The Net Present Value and Internal Rate of Return methods (NPV and IRR) sometimes agree, but not always. Given that the WACC for each project is 10% The NPV for Project W is $ 164.92 The NPV for Project X is $ 176.78 , With the IRR being worked out for these projects using the trial and error method, the result is as under : IRR for Project W 16.85% IRR for Project X 15.17% From this working, it can be seen that in the case of mutually exclusive projects, the NPV and IRR methods conflict. A key to resolving this conflict is the assumed reinvestment rate. The NPV calculation implicitly assumes that intermediate cash flows are reinvested at the cost of capital, and the IRR calculation assumes that the rate at which cash flows can be reinvested is the breakeven rate, or reinvestment rate. As as result, when evaluating mutually exclusive projects, the IRR is usually the better decision criterion.