Question

11-2: Net Present Value (NPV)
11-3: Internal Rate of Return (IRR)
Problem Walk-Through

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	$888.29	$250	$5	$15
Project L	-$1,000	$0	$240	$420	$765.23

The company's WACC is 10.0%. 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

NPV

NPV of project S = -1000 + 888.29 / ( 1 + 0.1)¹ + 250 / ( 1 + 0.1)² + 5 / ( 1 + 0.1)³ + 15 / ( 1 + 0.1)⁴

NPV = 28.15

NPV of project L = -1000 + 0 + 240 / ( 1 + 0.1)² + 420 / ( 1 + 0.1)³ + 765.23 / ( 1 + 0.1)⁴

NPV of project L = 36.56

IRR

IRR of project S using a financial calculator = 12.49%

Keys to use in a financial calculator: CF0 = -1000, CF1 = 888.29 F01 = 1, CF2 = 250 F02 = 1, CF3 = 5 F03 = 1, CF4 = 15 F04 =1, IRR CPT)

IRR of project L using a financial calculator = 11.19%

Keys to use in a financial calculator: CF0 = -1000, CF1 = 0 F01 = 1, CF2 = 240 F02 = 1, CF3 = 420 F03 = 1, CF4 = 765.23 F04 =1, IRR CPT)

When two project are mutuall exclusive and ranks differently with respect to IRR nad NPV, we always choose a project with a higher NPV. Here the better project is project L which has a higher NPV. The IRR of the better project is 11.1%.