CFA Level I · CFA Level I Exam · Capital Investments and Capital Allocation
Which of the following is the most likely cause of a conflict between NPV and IRR rankings of two mutually exclusive projects with conventional cash flows?
Differences in the timing of cash flows are the most likely cause. Projects with different patterns of cash inflows respond differently to the discount rate, so their NPV profiles can cross. Differences in project size can also cause conflicts. Multiple IRRs require non-conventional cash flows.
- ADifferences in the timing of cash flowsCorrect
- BA project having more than one IRR
- CUse of a discount rate below the risk-free rate
Explanation
Conflicts arise from differences in project scale or in the timing of cash flows. Projects with earlier cash flows can have higher IRRs because of the implicit reinvestment assumption. Multiple IRRs occur with non-conventional cash flows, not conventional ones.
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