Tesar Chemicals is considering Projects S and L,whose cash flows are shown below.These projects are mutually exclusive,equally risky,and not repeatable.The CEO believes the IRR is the best selection criterion,while the CFO advocates the NPV.If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV,how much,if any,value will be forgone,i.e. ,what's the chosen NPV versus the maximum possible NPV? Note that (1)"true value" is measured by NPV,and (2)under some conditions the choice of IRR vs.NPV will have no effect on the value gained or lost.

Question

Quizplus · Accepted Answer

To compare the two projects using the IRR and NPV methods, we need to calculate the IRR and NPV for each project:

IRR_S = 19.95%
NPV_S = $107.53

IRR_L = 15.76%
NPV_L = $124.47

According to the CEO's criteria, we would choose Project S because it has a higher IRR. However, the higher IRR of S comes at the cost of a lower NPV compared to Project L. The maximum possible NPV is the NPV of Project L.

Therefore, the forgone value is:

Maximum possible NPV - Chosen NPV = $124.47 - $107.53 = $16.94, which is closest to option C: $124.47 - $107.53 = $16.94.

Tesar Chemicals Is Considering Projects S and L,whose Cash Flows