Question

Bruins R Us is trying to choose between the following two mutually exclusive on-line game projects. Assume the discount rate for the company is 10 percent.

Year	A	B
IRR	26.67%	32.07%
0	-40,000	-15,000
1	21,000	8,500
2	21,000	8,500
3	21,000	8,500

Required:

1. Based on the IRR, which project should be accepted? What is main problem with IRR in the case?

2. Calculate the NPV of two projects. Based on the NPV, which project should be accepted?

3. Which project should be chosen and which investment rule would be applied, why?

Answer 1

1.Since Project B has the higher IRR , so it is good to choose the project which is yielding a Higher IRR based on the IRR criteria.The main problem with the IRR is it does not take account into realistic cost of capital. It is prudent to estmimate only low return ( risk free return ) as a discount factor. IRR theory does not actually take into account timing of cash flows

2.

Computation of NPV
Year	Project A	Project B	Disc @ 10%	DCF for project A	DCF for project B
0	-40000	-15000	1	-40000	-15000
1	21000	8500	0.909090909	19090.90909	7727.272727
2	21000	8500	0.826446281	17355.3719	7024.793388
3	21000	8500	0.751314801	15777.61082	6386.175808
		NPV		12223.89181	6138.241923

Since project A has higher NPV, so project A is acceptable.

3. Good to take investment decision based on the NPV criteria always because NPV measures the excess return over the return in the absolute terms. And in NPV, more realistic Cost of capital is used as a discount factor.he main problem with the IRR is it does not take account into realistic cost of capital. It is prudent to estmimate only low return ( risk free return ) as a discount factor. IRR theory does not actually take into account timing of cash flows.