Projects S and L, whose cash flows are shown below, are mutually exclusive, equally risky, and not repeatable. Hooper Inc. is considering which of these two projects to undertake. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under certain conditions choosing projects on the basis of the IRR will not cause any value to be lost because the project with the higher IRR will also have the higher NPV, so no value will be lost if the IRR method is used.
A) $134.79
B) $141.89
C) $149.36
D) $164.29
E) $205.36

Question

Projects S and L, whose cash flows are shown below, are mutually exclusive, equally risky, and not repeatable. Hooper Inc. is considering which of these two projects to undertake. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under certain conditions choosing projects on the basis of the IRR will not cause any value to be lost because the project with the higher IRR will also have the higher NPV, so no value will be lost if the IRR method is used. 
A) $134.79 
B) $141.89 
C) $149.36 
D) $164.29 
E) $205.36

Quizplus · Accepted Answer

We need to compare the NPV of both projects at a certain cost of capital. Using the IRR to make this decision can lead to value being forgone in cases where the cash flows of the projects differ in timing and magnitude. At a cost of capital of 14%, the NPV of Project S is $113.76 while the NPV of Project L is $263.12. Therefore, by choosing Project S based solely on the higher IRR, an NPV of $149.36 ($263.12 - $113.76) will be forgone. Thus, the best choice is Project L.

Projects S and L, Whose Cash Flows Are Shown Below