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	$896.74	$240	$10	$10
Project L	-$1,000	$0	$260	$380	$840.52

The company's WACC is 10.5%. 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=896.74/1.105+240/1.105^2+10/1.105^3+10/1.105^4

=$1022.20

NPV=Present value of inflows-Present value of outflows

=(1022.20-1000)

=$22.20(Approx)

L

Present value of inflows=260/1.105^2+380/1.105^3+840.52/1.105^4

=$1058.34

NPV=1058.34-1000

=$58.34(Approx).

Hence L is a better project having higher NPV.

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

1000=260/1.0x^2+380/1.0x^3+840.52/1.0x^4

Hence x=irr=irr=12.40%(Approx).