Practice question · Multiple choice
Two projects both have an IRR of 20%. One is a 5,000€ kiosk, the other a 5 million€ factory. Why does the firm still need NPV to choose?
Hints
- Would you rather have 20% of a small number or 20% of a large one?
- Ask what units each measure reports its answer in.
Show the answer
C. Because IRR is a rate and says nothing about size
Why
A percentage is scale-blind by construction, and shareholders bank euros rather than rates. Option 3 gets IRR backwards, it is defined by discounting, being the rate that sets NPV to zero. This is why capital budgeting ranks on NPV and reports IRR alongside as a sanity check.
Practise NPV and IRR
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More questions on NPV and IRR
- A project’s IRR is 18% and the firm’s cost of capital is 11%. By the IRR rule, what should the firm do?
- Order the steps of a discounted-cash-flow appraisal.
- A project costs 200k€ and pays 110k€ at the end of each of years 1 and 2. At r = 10%, set the slider to its…
- Match each appraisal concept to its meaning.