The NPV Rule & The IRR Rule

The NPV rule:

NPV > 0, accept

The IRR rule:

IRR > opportunity cost of capital (hurdle rate), accept

For mutually exclusive projects:

NPV rule: Choose the candidate with the higher positive NPV.

IRR rule: Choose the candidate with the higher IRR.

When the IRR and NPV rules conflict in ranking projects (due to size of projects, timing of cash flows), we should take directions from the NPV rule.

[Practice Problems] Suppose a company has only €1,000,000 available to invest. The three projects available are described in the table. If the opportunity cost of capital is 12%, which project should be accepted?

[Solutions] The projects are mutually exclusive because the amount to invest is constrained to €1,000,000. The NPV rule should be used.

Project A NPV = –€1,000,000 + €1,200,000/(1.12) = €71,429

Project B NPV = –€1,000,000 + €1,600,000/(1.12)³ = €138,848

Project C NPV = –€500,000 + €850,000/(1.12)³ = €105,013