Question

Epsilon company is considering investing in Project X or Project Y. Project X generates the following cash flows: year “zero” = 322 dollars (outflow); year 1 = 280 dollars (inflow); year 2 = 280 dollars (inflow); year 3 = 369 dollars (inflow); year 4 = 158 dollars (inflow). Project Y generates the following cash flows: year “zero” = 230 dollars (outflow); year 1 = 120 dollars (inflow); year 2 = 100 dollars (inflow); year 3 = 200 dollars (inflow); year 4 = 120 dollars (inflow). The MARR is 10%. Compute the External Rate of Return (ERR) of the BEST project

PLEASE INCLUDE FORMULAS AND COMPLETE STEPS. THANKS

Answer 1

We will calculate the Net Present Value of Project X and Project Y.

NPV = Discounted Csh Inflow - Initial Investment

MARR = 10%

For Project X,

NPV = 280/1.1 + 280/1.1²  + 369/1.1³ + 158/1.1⁴ - 322 = 549.1.

For Project Y,

NPV = 120/1.1 + 100/1.1²  + 200/1.1³ + 120/1.1⁴ - 230 = 193.96.

Since NPV(X) > NPV(Y), we will take project X.

External Rate of Return for project X = At which rate FV value of investment will be equal to the dicounted cash inflow ; 322*(1+ERR)⁴ = 280*1.1³+280*1.1² + 369*1.1+158

ERR = 41.07%.