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CMA Intermediate · Financial Management and Business Data Analytics · Capital Budgeting

A firm has two mutually exclusive projects. Project X has a higher NPV but a lower IRR than Project Y. Under the NPV approach consistent with the firm's objective of shareholder wealth maximisation, which action is appropriate?

Accept Project X. When rankings conflict for mutually exclusive projects, the higher NPV is preferred because NPV shows the absolute rupee addition to shareholder wealth, the objective of financial management, whereas IRR is only a percentage return and may favour a smaller or shorter project.

  1. AAccept Project Y because IRR is higher
  2. BAccept Project X because it adds more absolute valueCorrect
  3. CAccept both projects
  4. DReject both projects because their rankings conflict

Explanation

For mutually exclusive projects, NPV measures the absolute increase in shareholder wealth, which is the firm's objective. IRR is a percentage and can mislead when scale or timing differ. So the project with the higher NPV, X, is chosen. Accepting both is impossible because the projects are mutually exclusive.

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