A firm is considering Projects S and L,whose cash flows are shown below.These projects are mutually exclusive,equally risky,and not repeatable.The CEO wants to use the IRR criterion,while the CFO favors the NPV method.You were hired to advise the firm on the best procedure.If the wrong decision criterion is used,how much potential value would the firm lose?
A)$188.68
B)$198.61
C)$209.07
D)$219.52
E)$230.49

Question

A firm is considering Projects S and L,whose cash flows are shown below.These projects are mutually exclusive,equally risky,and not repeatable.The CEO wants to use the IRR criterion,while the CFO favors the NPV method.You were hired to advise the firm on the best procedure.If the wrong decision criterion is used,how much potential value would the firm lose? 
A)$188.68 
B)$198.61 
C)$209.07 
D)$219.52 
E)$230.49

Quizplus · Accepted Answer

Using the IRR criterion, Project S has an IRR of 15.24% and Project L has an IRR of 13.85%. Since both projects have positive IRRs, the CEO may be inclined to choose the project with the higher IRR, which is Project S.

Using the NPV method, assuming a discount rate of 10%, Project S has an NPV of $1,356.72 and Project L has an NPV of $1,494.79. Therefore, the CFO may be inclined to choose Project L based on its higher NPV.

If the firm were to choose Project S using the IRR criterion, it would lose the potential value of $209.07, which is the difference between the NPV of Project S ($1,356.72) and the NPV of Project L ($1,494.79). Therefore, it is important to use the correct decision criterion to ensure that the firm maximizes its potential value.

A Firm Is Considering Projects S and L,whose Cash Flows