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

Ganga Foods' project A has IRR 18% and NPV ₹40,000 at the 12% cost of capital; project B is mutually exclusive, with IRR 15% and NPV ₹55,000 at the same cost of capital. Both have positive NPV and conflict arises because of different cash flow timing. Which is the best recommendation under the standard theory?

Accept project B. When NPV and IRR rank mutually exclusive projects differently, NPV is preferred because it shows the absolute increase in shareholder wealth and assumes reinvestment at the cost of capital, whereas IRR assumes reinvestment at the project's own IRR, which is often unrealistic.

  1. AAccept B, since higher NPV adds more wealth and assumes reinvestment at the cost of capitalCorrect
  2. BAccept A, since higher IRR always maximises shareholder wealth
  3. CAccept both, since both exceed the cost of capital
  4. DReject both, since IRRs differ from each other

Explanation

For mutually exclusive projects with conflicting ranking, NPV is preferred because it measures absolute wealth added and assumes reinvestment at the cost of capital, which is more realistic than reinvestment at IRR. Accepting A because of higher IRR ignores scale and timing. Accepting both is not possible for mutually exclusive projects.

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