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CS Executive · Corporate Accounting and Financial Management · Capital Budgeting

Two mutually exclusive projects have conventional cash flows. Project P has the higher IRR, while Project Q has the higher NPV at the firm's cost of capital. Which decision is consistent with the wealth-maximisation objective?

Project Q should be accepted. When NPV and IRR rankings conflict for mutually exclusive projects, NPV is preferred because it measures the absolute addition to shareholders' wealth, whereas IRR is a percentage rate that ignores the size of the investment.

  1. AAccept Project P because a higher percentage return is always better
  2. BAccept Project Q because it adds more absolute value to shareholders' wealthCorrect
  3. CAccept both projects since each has a positive NPV
  4. DReject both projects because their rankings conflict

Explanation

For mutually exclusive projects, the NPV criterion measures the absolute increase in shareholders' wealth, so the project with the higher NPV is chosen when rankings conflict. IRR ignores the scale of the investment. Accepting P because of its higher IRR could leave value unrealised.

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