Chapter 11, Problem 6Q

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

Chapter
Section

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

# Discuss the following statement: If a firm has only independent projects, a constant WACC, and projects with normal cash flows, the NPV and IRR methods will always lead to identical capital budgeting decisions. What does this imply about the choice between IRR and NPV? If each of the assumptions were changed (one by one), how would your answer change?

Summary Introduction

To discuss: The given statement and the choice between NPV and IRR.

Introduction:

Net Present Value (NPV):

It is a method under capital budgeting which includes the calculation of net present value of the project in which a company is investing. The calculation is done by calculating the difference between the value of cash inflow and value of cash outflow after considering the discounted rate.

Weighted Average Cost of Capital (WACC):

It is the discounted rate that has been calculated by the company on the basis of which the present values of cash outflows and inflows are calculated under capital budgeting.

Internal Rate of Return (IRR):

It refers to the rate of return that is computed by the company to make a decision regarding the selection of a project for investment. This rate provides the basis for selection of projects with lower cost of capital and rejection of project with higher cost of capital.

Explanation

The given statement is true because of the reasons as follows:

• Since independent projects are those that can be expected without affecting decisions related to other project, they can be accepted together or rejected together.
• With constant WACC and normal cash flows, a firm with all independent projects will provide the same capital budgeting decision in NPV and IRR both cases. It is because all projects with positive NPV and IRR will select a greater cost of capital.

The above statement implies:

• If the firm has only independent projects then only the decisions of capital budgeting will be same in both the cases of NPV and IRR method as more projects can be accepted at a time...

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