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mediumFinancial Analyst interview question

Two mutually exclusive projects rank differently on NPV and IRR. Which would you choose and why?

What the interviewer wants to hear

  • Choose the project with the higher NPV when projects are mutually exclusive
  • NPV measures absolute value created at the cost of capital
  • IRR ignores scale and assumes reinvestment at the IRR
  • Conflicts come from different size or timing of cash flows
  • Can use incremental IRR or MIRR as a check

Model answer

For mutually exclusive projects I go with the higher NPV, as long as it is computed at the right cost of capital. NPV tells me how much value, in rupees or dirhams, a project adds to the company. IRR is a percentage, so it ignores scale: a small project can earn 40% on 1 crore while a larger one earns 20% on 50 crore and creates far more value. Conflicts also appear when cash flow timing differs, because IRR implicitly assumes cash is reinvested at the IRR itself, which is often unrealistic, while NPV assumes reinvestment at the cost of capital. To check, I can compute the IRR of the incremental cash flows between the two projects; if it is above the cost of capital, the bigger project is better. I still report IRR because managers like it, but the decision rests on NPV.

Can you answer it under time pressure?

Take a timed medium round and get scored on every answer.

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