Question

In which of the following cases can NPV and IRR lead to different decisions?

I. Project cash flows are conventional.
II. The IRR is negative.
III. An investment decision involves mutually exclusive choices.
A) I only
B) III only
C) I and II only
D) I and III only
E) II and III only

Answer 1

NPV and IRR can lead to different decisions in the cases of conventional cash flows, negative IRR, and mutually exclusive choices. The correct option is D.

Step-by-step explanation:

The correct answer is D) I and III only. NPV (Net Present Value) and IRR (Internal Rate of Return) are two methods used to evaluate the profitability of an investment project. They can lead to different decisions under certain circumstances:

1. If the project cash flows are conventional, meaning there is an initial outflow followed by inflows, then the NPV and IRR calculations will usually lead to the same decision.
2. If the IRR is negative, indicating that the project's rate of return is less than the required rate of return, the IRR may suggest accepting the project while the NPV may suggest rejecting it.
3. When an investment decision involves mutually exclusive choices, meaning you can only choose one of several options, NPV and IRR can lead to different decisions. In such cases, NPV provides a better measure of profitability as it considers the cash flows over the entire project's life. The correct option is D.