Question

IRR and NPV A company is analyzing two mutually exclusive projects, S and L, with the following cash flows: 0 1 2 3 4 Project S -$1,000 $876.05 $260 $15 $5 Project L -$1,000 $10 $260 $380 $771.23 The company's WACC is 9.5%. What is the IRR of the better project? (Hint: The better project may or may not be the one with the higher IRR.) Round your answer to two decimal places.

Answer 1

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

S:

Present value of inflows=876.05/1.095+260/1.095^2+15/1.095^3+5/1.095^4

=$1031.79

NPV=Present value of inflows-Present value of outflows

=$1031.79-$1000

=$31.79

L:

Present value of inflows=10/1.095+260/1.095^2+380/1.095^3+771.23/1.095^4

=$1051.85

NPV=Present value of inflows-Present value of outflows

  =$1051.85-$1000

=$51.85

Hence L is the better project.

For L:

Let irr be x%
At irr,present value of inflows=present value of outflows.

1000=10/1.0x+260/1.0x^2+380/1.0x^3+771.23/1.0x^4

Hence x=irr=11.20%(Approx).