Question

You have to decide between projects A and project B. No project is not an option. The cash flows are as follows:

Project A: t=0: -9000; t=1: -2200; t=2: 4000; t=3: 2057

Project B: t=0: -8000; t=1: -4480; t=2: 4000; t=3: 3644

Find the IRR of the incremental project. MARR=15%. Choose the best answer.

a)	7%
b)	8%
c)	9%
d)	22%
e)	23%
f)	24%

Answer 1

Incremental IRR is a way to analyse financial return when there are two investing opportunities with different initial investments.

The incremental cashflows are calculated by subtracting cashflows of higher initial investment project from that of lower investment.

The incremental cashflows will be as follows:

t=0: -1000; t=1: 2280; t=2: 0; t=3: -1587.

IRR is the discount rate at which NPV is 0.
Let IRR be r, then -C+C1/(1+r)+C2/(1+r)^2+....Cn/(1+r)^n= 0; where C is initial investment, C1 to Cn are annual cashflows and r is IRR.

-1000+2280/(1+r)+0/(1+r)^2+(-1587)/(1+r)^3= 0.

2280/(1+r)-1587/(1+r)^3= 1000.

Among the options, 23% is the best answer. (Option e).