CFA® Level 1: Internal Rate of Return vs. Net Present Value

Internal Rate of Return vs. Net Present Value

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Question

Project A has an internal rate of return of 18 percent, while Project B has an internal rate of return of 16 percent. However, if the company's cost of capital (WACC) is 12 percent, Project B has a higher net present value. Which of the following statements is most correct?

Answers

A. All of these answers are correct.

B. The crossover rate for the two project is less than 12 percent.

C. None of these answers are correct.

D. Assuming that the two projects have the same scale, Project A probably has a faster payback than Project B.

E. Assuming the timing of the two projects is the same, Project A is probably of larger scale than Project B. D

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Explanations

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A. B. C. D. E.

Explanation

Draw out the NPV profiles of these two projects. As B's NPV declines more rapidly with an increase in discount rates, this implies that more of the cash flows are coming later on. Therefore, Project A has a faster payback than Project B.

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