NPV/IRR Generalities – Question

The key to this question (and not a minor detail conceptually) is the timing of the CF’s given a constant discount rate. Since we know these are mutually exclusive projects w/ the same cumulative CF’s, the project w/ earlier cash flows will always have a greater PV.

Hi there, the best way to approach this question is to scratch out the answers that we know are not correct.

As project Smith has its cash flows happening later in life, we know that it is going to have a lower IRR than project Jones. This is because IRR assumes reinvestment of cash flows. Therefore we can rule out “A” as the correct answer.

Second, looking at option B. Quite obviously there will be levels at which both projects will fail to justify their investment, and there will also be levels at which their return (whether measured by IRR or NPV) will justify making the investment. Also, as the projects are mutually exclusive, we can say that there will be times when neither project justifies their investment, and at other times we will only select one of the projects. Therefore answer “B” looks pretty good so far….

But to confirm, let’s look at answer C: the trick here is to remember that the projects are mutually exclusive AND they have the same cash flows (just spread out at different times). Because of this we will always choose either to not invest (if the IRR