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CFA Level I · CFA Level I Exam · Capital Investments and Capital Allocation

Two mutually exclusive projects have conventional cash flows. Project X has a higher NPV at the company's cost of capital, while Project Y has a higher IRR. Which project should the analyst most likely recommend?

Project X should be recommended. For mutually exclusive projects, NPV measures the expected increase in shareholder wealth in currency terms, so it overrides a conflicting IRR ranking. The project with the higher IRR may add less total value, so IRR should not decide the choice.

  1. AProject Y, because it has the higher IRR
  2. BProject X, because it has the higher NPVCorrect
  3. CNeither project, because the rankings disagree

Explanation

NPV measures the absolute increase in shareholder wealth, while IRR is a percentage rate. When rankings conflict for mutually exclusive projects, NPV is the preferred criterion. Choosing by IRR could select a project that adds less value. Rejecting both is wrong because both have positive NPV at the cost of capital.

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