CS Professional · Strategic Management and Corporate Finance · Project Evaluation
Which of the following is a standard reason why NPV and IRR may rank mutually exclusive projects differently?
Conflicts arise from differing cash flow timing patterns, because NPV assumes reinvestment at the cost of capital while IRR assumes reinvestment at the project's own IRR. Where the discount rate is below the crossover rate, the two methods can rank projects differently.
- AProjects having the same initial outlay and identical cash flows
- BDifferences in the timing pattern of cash flows, causing an implicit reinvestment rate assumption mismatchCorrect
- CUse of a single discount rate for all years
- DProjects having a life of exactly one year
Explanation
NPV assumes intermediate cash flows are reinvested at the cost of capital, while IRR assumes reinvestment at the IRR itself. When cash flow timing differs, the rankings can diverge below the crossover rate. Identical projects or one-year projects do not create conflict.
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