Certified Professional In Financial Management (CPFM)

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A financial manager is presented with two mutually exclusive projects, Project A and Project B. Both projects have positive NPVs, but Project A has a higher IRR. However, Project B has a significantly larger NPV. Assuming capital is not rationed, which project should the manager select and why?

Project A, because its higher IRR indicates a more efficient use of capital. Project B, because the primary goal of capital budgeting is to maximize firm value, which is directly measured by NPV. Either project, as both have positive NPVs and will add value to the firm. Neither project until a profitability index is calculated to resolve the conflict between NPV and IRR.

Correct Answer:

Project B, because the primary goal of capital budgeting is to maximize firm value, which is directly measured by NPV.

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