Mutually Exclusive Projects

Companies often face choices between alternatives that cannot all be undertaken. For example, a company may have one piece of land and must decide whether to build a warehouse or an office building on it. Or it may need to choose between two different machines to do the same job.

When projects are mutually exclusive, the company should generally choose the one with the highest net present value, since that adds the most value. Other measures can give conflicting signals.

For example, Project A has a net present value of 120,000 and an internal rate of return of 25%. Project B has a net present value of 180,000 and an internal rate of return of 18%. Although A has the higher return rate, B adds more value, so B is usually preferred.

Conflicts between NPV and IRR often arise when projects differ in size or timing of cash flows. If projects have different lives, methods such as equivalent annual annuity may be used to compare them fairly.