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CS Executive · Corporate Accounting and Financial Management · Capital Budgeting

Which of the following is the most common reason why NPV and IRR can rank mutually exclusive projects differently?

Conflicts arise mainly from differences in the timing of cash flows (and scale or life), because NPV assumes reinvestment at the cost of capital while IRR assumes reinvestment at the project's own IRR, so rankings can differ when the discount rate lies below the crossover rate.

  1. ADifferences in the timing pattern of cash flows, which implies different reinvestment rate assumptionsCorrect
  2. BUse of straight-line depreciation in one project only
  3. CBoth projects having the same initial outlay and the same life
  4. DProjects having a positive NPV at the cost of capital

Explanation

NPV assumes intermediate cash flows are reinvested at the cost of capital, while IRR assumes reinvestment at the IRR itself. When the timing of inflows differs, the rankings can reverse at rates below the crossover rate. Same outlay and life would not by themselves cause such a conflict in general.

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