An investor is considering the two investments shown above.Her cost of capital is 9%.Which of the following statements about these investments is true?

Question

Quizplus · Accepted Answer

To determine the best investment, we need to calculate the NPV and IRR of both investments.

For Investment A: 
NPV = -1000 + (300)/(1+0.09)^1 + (500)/(1+0.09)^2 + (700)/(1+0.09)^3 = $411.44
IRR = 12.14%

For Investment B: 
NPV = -900 + (400)/(1+0.09)^1 + (400)/(1+0.09)^2 + (400)/(1+0.09)^3 + (400)/(1+0.09)^4 = $426.71
IRR = 11.91%

Since Investment B has a higher NPV, it is the better choice. The internal rate of return (IRR) is not a good criteria to choose between mutually exclusive projects since it can be unreliable in certain cases.

An Investor Is Considering the Two Investments Shown Above