Question

You are considering the following two projects and can take only one. Your cost of capital is 11.9%. The cash flows for the two projects are as follows​ ($ million):

Project	Year 0	Year 1	Year 2	Year 3	Year 4
A	-$103	28	34	44	53
B	-$103	53	44	34	24

What is the IRR of each project? Which project should you choose?

Select one:

a. IRR of Project A = 11.9%, IRR of Project B = 17.7%. Choose project B.

b. IRR of Project A = 17.7%, IRR of Project B = 21.7%. Choose project A.

c. IRR cannot be used to compare these projects. Choose project B because it has a higher NPV.

d. IRR of Project A = 17.7%, IRR of Project B = 21.7%. Choose project B.

Answer 1

When projects are mutually exclusive, i.e., only 1 project can be selected, We should always choose the project with the higher NPV

NPV = Present value of cash inflows - present value of cash outflows

Project A:

NPV = -103 + 28 / (1 + 0.119)¹ + 34 / (1 + 0.119)² + 44 / (1 + 0.119)³ + 53 / (1 + 0.119)⁴

NPV = $14.38

Project B:

NPV = -103 + 53 / (1 + 0.119)¹ + 44 / (1 + 0.119)² + 34 / (1 + 0.119)³ + 23 / (1 + 0.119)⁴

NPV = $19.08

c. IRR cannot be used to compare these projects. Choose project B because it has a higher NPV.