Question

Bausch Company is presented with the following two mutually exclusive projects. The required return for both projects is 19 percent.

Year            Project M          Project N
0                  -$140,000         -$355,000
1                   $63,500             $152,500
2                   $81,500             $180,000
3                   $72,500             $137,500  
4                   $58,500             $110,000

What is the IRR for each project?
What is the NPV for each project?
Which,if either, of the projects should the company accept?

Answer 1

Project M

Let the IRR be x.

Now , Present Value of Cash Outflows=Present Value of Cash Inflows

140,000 = 63,500 /(1.0x) +81,500/ (1.0x)^2 +72,500 /(1.0x)^3+ $ 58,500 /(1.0x)^4      

Or x= 34.471%

Hence the IRR is 34.47%

Project N

Let the IRR be y.

Now , Present Value of Cash Outflows=Present Value of Cash Inflows

355,000 =152,500/(1.0y) + 180,000 / (1.0y)^2  + 137,500 /(1.0y)^3 +  110,000/(1.0y)^4

Or y= 24.608%

Hence the IRR is 24.61%

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NPV of Project = Present Value of Cash Inflow - Present Value of cash Outflow

Project M :

= [ $ 63,500 * 1/ (1.19) ^ 1+ $ 81500* 1/ (1.19) ^ 2 + $ 72500* 1/ (1.19) ^ 3 + $ 58500* 1/ (1.19) ^ 4] - $ 140,000

= $ 43,108.55

Hence the correct answer is $ 43,108.55

Project N :

= [ $ 152,500 * 1/ (1.19) ^ 1+ $ 180000* 1/ (1.19) ^ 2 + $ 137500* 1/ (1.19) ^ 3 + $ 110000* 1/ (1.19) ^ 4] - $ 355,000

= $ 36,709.17

Hence the correct answer is $ 36,709.17

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Since the Net Present Value of Project M is more than the Net Present Value of Project N, the Project M must be accepted.

Hence the correct answer is Project M.