You have $1M dollars. There are two projects. Each requires an upfront investment of $1M, then generates positive cash flows every year after that. Project A has an NPV of $5M, an IRR of 10%. Project B has an NPV of $3M, an IRR of 15%. Which project should get funding? Explain why. If your answer depends on specific assumptions, state your assumptions

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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You have $1M dollars. There are two projects. Each requires an upfront investment of $1M, then generates positive cash flows every year after that. Project A has an NPV of $5M, an IRR of 10%. Project B has an NPV of $3M, an IRR of 15%. Which project should get funding? Explain why. If your answer depends on specific assumptions, state your assumptions. 

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Project A should be chosen in this instance because of its larger NPV. Despite having a better IRR of 15%, project B won't be chosen because its NPV of $3M is lower than project A's NPV of $1M. IRR has an inherent fault in that it presupposes that all cash flows can be reinvested at the internal rate of return, making NPV a superior technique of capital budgeting. This is a problematic premise since it cannot be ensured that possibilities that are as lucrative will be present as soon as financial flows start to flow.

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