"quantity"exercise:net present value

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Questions 1:

When considering two mutually exclusive capital budgeting projects with conflicting rankings—one has a higher positive net present value (NPV), the other has a higher internal rate of return (IRR)—the most appropriate conclusion is to choose the project with the:

A 、higher NPV

B、 higher IRR.

C、 shorter payback.

Questions 2:

A Type I error is best described as the probability of:

A 、failing to reject a false null hypothesis.

B 、rejecting a true alternative hypothesis.

C 、rejecting a true null hypothesis.

View answer resolution

【Answer to question 1】A

【analysis】

A is correct. The project with the higher NPV should be undertaken because NPV measures the increase in wealth as a result of taking the project. For mutually exclusive projects, IRR may give incorrect decisions as a result of scale and/or cash flow timing effects. Payback is not an economically sound method for evaluation of capital projects.

B is incorrect. When IRR and NPV conflict in ranking, the higher NPV project is chosen.

C is incorrect. Payback suffers from severe deficiencies as a decision tool. In particular, because it is not economically sound, the payback period should not be used to evaluate projects.

【Answer to question 2】C

【analysis】

C is correct. A Type I error is the mistake of rejecting the null hypothesis when it is, in fact, true.

A is incorrect. This is the definition of a Type II error.

B is incorrect. This is an entirely wrong statement and it is not one of possible outcomes when we test a null hypothesis.

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