Calculating NPV and IRR of Mutually Exclusive Projects

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Summarizing the above discussion the timings and pattern of cash flows can produce conflicting results in the NPV and IRR methods of project evaluation. As you can see, Project A has higher IRR, while Project B has higher NPV. In mutually exclusive projects, cash flows of one project can be adversely affected by the acceptance of the other project. Next you will check in how many years the cost of project would be recovered and by what period of time the that project will start providing the benefits.

Posts are for general information, are not intended to substitute for informed professional advice medical, legal, veterinary, financial, etc. In this scenario, you would first analyze the project cost and try to evaluate its cash inflows and outflows. In this case and the rule of thumb the firm will choose project A because it increases shareholder value the most. IRR is a relative measure, and it will rank projects offering best investment return higher regardless of the total value added.

Mutually Exclusive Projects

Internal Rate Of Return And Mutually Exclusive Projects……. While considering the mutually exclusive projects, can be misleading. Investment projects are said to be mutually exclusive if only one project could be accepted and others would have to be rejected. The cash flows of one project may increase over time, while those of others may decrease and vice versa. The major drawback with the IRR method is that for , it can give contradictory investment decision when compared with NPV. Consider the following example. In the above example A and B are mutually exclusive projects. Cash inflows for Project A are increasing over the period of time while for Project B these are declining. But decision on the basis of NPV evaluation implies that project B is more viable. Thus on the basis of mere IRR the company may select less profitable project. The cash outflow of the projects may differ. Consider the following example: Project A requires an initial outlay at the beginning of the project while Project B needs cash outflow in year 2 and year 4 also. Decision based on IRR method leads to select project B but NPV of project B is less than of Project A. Summarizing the above discussion the timings and pattern of cash flows can produce conflicting results in the NPV and IRR methods of project evaluation.

The payback-period method calculates how long it will take to earn back the project's initial investment. Without careful analysis, an investor might pan a high NPV project ignoring the fact that many smaller NPV projects could be completed with the same investment resulting in higher aggregate NPV. Consider the following example: Project A requires an initial outlay at the beginning of the project while Project B needs cash outflow in year 2 and file 4 also. What is the IRR of the better project. Hint: Note that the better project may or may not be the one with the higher IRR. This assumption is unrealistic because there is no guarantee that reinvestment at IRR can be achieved. Mutually exclusive projects irr and npv am not glad to understand why. Let assume that your organization has asked you to do an analysis — Whether the new project will be beneficial. Investment projects are said to be mutually exclusive if only one project could be accepted and others would have to be rejected.