Dear all,

I came over a question in the PM simulator and as well again in an online

Practice , where I would not agree with the answer given in regards to IRR and NPV:

**(...)**
Based on the information provided below, which project would you recommend pursuing?

Project I, ...

Project II, with NPV of US $ 500,000;

Project III, with IRR (Internal rate of return) of 15%

Project IV, ...

Correct Choice:

Project III

Explanation:

Project III has an IRR of 15%, which means the revenues from the project equal the cost expended at an interest rate of 15%. This is a definitive and a favorable parameter, and hence can be recommended for selection.

Information provided on projects II and (...) is not definitive, and hence neither of projects II and(..) qualifies for a positive recommendation.

**(...)**
In my view this is not correct. The positive NPV indicates that today's (risk and time adjusted) value of the revenues exceeds today's (risk and time adjusted) value of the project cost by 500.000 - so this is as good as the IRR.

In fact, as an NPV calculation includes the required risk adjusted discounting rate, it contains more information than the IRR - as IRR does not provide any information about the required risk adjusted return. It could be that the project is highly risky, and therefore comparable investments would require higher return rates.

Pls see also

Wiki on IRR
"(...) As an investment decision tool, the calculated IRR should not be used to rate mutually exclusive projects, but only to decide whether a single project is worth investing in. In cases where one project has a higher initial investment than a second mutually exclusive project, the first project may have a lower IRR (expected return), but a higher NPV (increase in shareholders' wealth) and should thus be accepted over the second project (assuming no capital constraints).

(...)

Despite a strong academic preference for NPV, surveys indicate that executives prefer IRR over NPV.[6] Apparently, managers find it easier to compare investments of different sizes in terms of percentage rates of return than by dollars of NPV. However, NPV remains the "more accurate" reflection of value to the business. IRR, as a measure of investment efficiency may give better insights in capital constrained situations. However, when comparing mutually exclusive projects, NPV is the appropriate measure."

Any comments?

Timmo