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ACCA Strategic Professional · Strategic Business Leader · Financial analysis and decision-making techniques

Zentara Ltd is comparing two mutually exclusive projects. Project A has an NPV of $120,000 at the company's 10% cost of capital and an IRR of 14%. Project B has an NPV of $150,000 at 10% and an IRR of 12%. Both have similar lives and the company faces no capital rationing. Which recommendation is consistent with the objective of maximising shareholder wealth?

Accept Project B. With mutually exclusive projects and no capital rationing, the higher NPV ($150,000) adds more absolute wealth for shareholders. IRR is a percentage and ignores scale, so the higher IRR of Project A should not override the NPV ranking.

  1. AAccept Project A because its IRR is higher
  2. BAccept Project B because its NPV is higherCorrect
  3. CAccept both projects because both IRRs exceed 10%
  4. DReject both projects because the IRRs differ

Explanation

For mutually exclusive projects without capital rationing, the project with the higher NPV adds more to shareholder wealth. IRR is a relative percentage measure and ignores project scale, so Project A's higher IRR is misleading. Accepting both is not possible because they are mutually exclusive.

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