hardMultiple ChoiceObjective-mapped
PK0-005 Practice Question: A project is in the initiation phase, and the…
A project is in the initiation phase, and the sponsor asks the project manager to evaluate which project to select among three proposals. Proposal A has an NPV of $150,000, Proposal B has a payback period of 18 months, and Proposal C has an internal rate of return (IRR) of 12%. The organization's cost of capital is 10%. Which project should be selected based on the most financially sound criterion?
⚠ Common exam trap
It's easy for candidates to choose Proposal C (IRR) because 12% > 10% seems favorable, but they overlook that NPV is the superior criterion for selecting among mutually exclusive projects, as IRR can rank projects incorrectly when cash flow patterns differ or when the cost of capital changes.
Answer choices
Why each option matters
Answer the question above first, then reveal the full breakdown to understand why each option is right or wrong.
Correct answer & explanation
✓
Proposal A
Proposal A has an NPV of $150,000, which is a direct measure of the project's value creation in today's dollars. Since NPV accounts for the time value of money and the organization's cost of capital (10%), a positive NPV indicates the project is expected to generate value above the required return. Among the options, NPV is the most financially sound criterion because it quantifies absolute wealth increase, unlike payback period (which ignores time value and cash flows after payback) or IRR (which can be misleading for mutually exclusive projects).
Answer analysis
Option-by-option breakdown
For each option: why learners choose it and why it is or isn't the right answer here.
- ✗
Proposal C
Why it's wrong here
IRR of 12% exceeds cost of capital, but without comparing NPV, it may not be the best choice.
- ✗
Proposal B
Why it's wrong here
Payback period is simple but does not consider profitability or time value of money.
- ✗
Cannot determine without additional data
Why it's wrong here
Sufficient data provided; NPV is definitive.
- ✓
Proposal A
Why this is correct
NPV of $150,000 is positive and directly indicates added value. It is the best criterion.
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