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CS Professional · Strategic Management and Corporate Finance · Project Evaluation

Two mutually exclusive projects, A and B, are evaluated by Kaveri Engineering Ltd. Project A has IRR 22% and NPV Rs 3,00,000 at the cost of capital; Project B has IRR 18% and NPV Rs 4,50,000 at the same rate. There is no capital rationing. Which choice and reasoning is most consistent with sound finance theory?

Select Project B. When projects are mutually exclusive and there is no capital rationing, the higher NPV, Rs 4,50,000 against Rs 3,00,000, shows the greater addition to shareholder wealth. A higher IRR can mislead because it ignores the scale of investment and timing of flows.

  1. ASelect A because higher IRR always maximises shareholder wealth
  2. BSelect B because it has the higher NPV, which measures absolute wealth additionCorrect
  3. CSelect A because its profitability index must be higher
  4. DSelect neither because the IRRs differ

Explanation

For mutually exclusive projects without capital rationing, NPV is the preferred criterion because it measures absolute increase in shareholder wealth. IRR can conflict due to differences in scale or timing of cash flows. Selecting A on IRR alone would forgo Rs 1,50,000 of additional value. PI cannot be inferred from the data given.

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