Question

IRR: Mutually exclusive projects Ocean Pacific Restaurant is evaluating two mutually exclusive projects for expanding the restaurant's seating capacity. The relevant cash
flows for the projects are shown in the following table. The firm's cost of capital is 4%.

	Project X	Project Y
Initial Investment (CF)	980,000	363,000
Year	Cash inflows (CF)
1	150,000	110,000
2	170,000	98,000
3	220,000	93,000
4	270,000	82,000
5	340,000	67,000

a. calculate the IRR to the nearest whole percent for each of the projects.

b. assess the acceptability of each project on the basis of the IRRs found in part a.

c. which project, on this basis, is preferred?

Answer 1

1. Calculation of Project X IRR using financial calculator:

CF0 = -980,000; CF1 = 150,000; CF2 = 170,000; CF3 = 220,000; CF4 = 270,000; CF5 = 340,000

IRR -> CPT = 4.8588% i.e 5%

Calculation of Project Y IRR using financial calculator:

CF0 = -363,000; CF1 = 110,000; CF2 = 98,000; CF3 = 93,000; CF4 = 82,000; CF5 = 67,000

IRR -> CPT = 8.2906% i.e 8%

2&3. As both the projects IRR is greater than cost of capital of 4%, both the projects can be accepted. However, as the projects are mutually exclusive; and IRR of project Y is higher if compared to Project X, Project Y should be accepted