if the projects cost of capital is 10% and the projects are mutually exclusive, what project do you have to choose?
The correct answer and explanation is:
To determine which project to choose when projects are mutually exclusive and the cost of capital is 10%, you need to evaluate each project using Net Present Value (NPV) at the given cost of capital.
✅ Correct Answer: Choose the project with the higher NPV at 10% cost of capital.
💡 Explanation:
When dealing with mutually exclusive projects, you can only choose one, even if both are profitable. In such cases, the Net Present Value (NPV) method is the most appropriate evaluation tool, especially when compared to Internal Rate of Return (IRR), Payback Period, or other metrics.
🔍 Why NPV?
NPV measures the net gain in wealth generated by a project, discounted at the firm’s cost of capital (10% in this case). It accounts for the time value of money, which means a dollar today is worth more than a dollar tomorrow.
- If NPV > 0 → the project adds value.
- If NPV < 0 → the project destroys value.
- When comparing multiple mutually exclusive projects → choose the one with the highest positive NPV.
📊 IRR vs. NPV (Why not IRR?)
While the Internal Rate of Return (IRR) is a popular method, it can be misleading in cases of:
- Mutually exclusive projects: IRR might suggest a project with a higher percentage return but lower actual value created.
- Non-conventional cash flows: IRR may give multiple values or none.
Therefore, when projects compete against each other and the cost of capital is known (10%), NPV gives the correct decision.
✅ Summary:
If two or more projects are mutually exclusive and your cost of capital is 10%, compute the NPV of each project at 10%.
👉 Choose the project with the highest NPV.
This ensures you’re maximizing value for the firm or investors.