Evaluating mutually exclusive projects with capital budgeting techniques Case Solution

NPV also has an advantage over IRR, as when the project has non-normal cash flows, the NPV method will always lead to a singular correct accept-or-reject decision. NPV is the acceptable method when there are non-normal cash flows, and it exists when evaluating mutually exclusive project with conflicting NPV profiles as well asthe cost of capital is less than the crossover rate. When fewer conditions are present, the NPV and IRR results will conflict in which the project is accepted or rejected.

1.    What does he find? Do NPVs confirm his earlier findings?

Michael graduated with MBA degree, however he does not have better accuracy in the calculations of NPV and IRR, therefore he took some guidance from his colleagues, and after getting the required information Michael tried to formulate the scenario so as to get the results. He researched through various books regarding NPV and IRR and cleared many misconceptions.

NPV cleared the main conflicts of the projects however,the decision was still pending regarding more information and avoiding the risks. However, Michael did not want to miss anything in his report to impress his boss by providing accurate results.

2.    Which project is better for this company?

In my opinion, NPV and IRR both are acceptable in the mutually exclusive projects. These are the best terms to find the better project. If I was in this same situation, I would go for IRR because from it, I would be able to generate more revenue. If one invests somewhere, they do it with the belief that they will try to get as much profit as they can as well as the business should still be beneficial in the long-term. Project A will be better for the company because in this project, the company will generate more return based on less investment.Moreover, the payback period is also less according to the investment.

The NPV and IRR will always lead to the same decision unless one or both of the projects are not normal in the sense of having a change of sign in the cash flow; for example, one or more cash flows and investment followed by a series of cash inflows. A project with a substantially higher IRR value than other available options would still provide a better chance of strong growth.

3.    IRR choose high cost of capital or a low cost of capital?

IRR is always calculated on the mutually exclusive project, where both projects cross each other, and the crossover rate is generated at the intersecting points. Mostly, IRR will be chosen under the low cost of capital as less capital would provide a higher rate of return. Furthermore, IRR is used as the growth rate of the project. IRR is calculated by the project cash flow and the invested outflow, in both the projects, the expected IRR amount is given from which one can closely calculate the accurate IRR rate. Moreover, IRR does not mostly consider the cost of capital, therefore it should not be used to compare the projects of different durations.

4.    NPV? Choose the same project whether a firm has a high cost of capital or a low cost of capital?

NPV identifies the present value of the invested amount and the amount of cash flow in the given time period. NPV is calculated on the nature of cash flows and its present value. NPV is a financial analytical method that aggregates a series of discounted cash flows into present day values. The capital cost of the project is assumed to increase at the start of the base year during the time of analysis. In any of these projects, the NPV is always in the same formof high and low capital………………..

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