Question

A firm must choose between two mutually exclusive projects, A & B. Project A has an initial cost of $11000. Its projected net cash flows are $900, $2000, $3000, $4000, and $5000 at the end of years 1 through 5, respectively. Project B has an initial cost of $15000, and its projected net cash flows are $7000, $5000, $3000, $2000, and $1000 at the end of years 1 through 5, respectively. At what cost of capital would the firm be indifferent to the two projects (i.e. be willing to choose either one)? 3.47% 6.58% 6.82% 7.66% 7.18%

Answer 1

Project A	-11000	900	2000	3000	4000	5000
Project B	-15000	7000	5000	3000	2000	1000
Change	-4000	6100	3000	0	-2000	-4000

Now we will calculate the IRR of the change and this IRR will be the rate for which two projects will be indifferent.

IRR is the rate for which NPV equlas zero.

0 = 6100/(1+IRR)^1 + 3000/(1+IRR)^2 + 0/(1+IRR)^3 + (-2000)/(1+IRR)^4 + (-4000) /(1+IRR)^5+ (-4000)

Now, we will use the heat and trial method to get that value for which the above equation will be satisfied.

IRR = 7.66% Answer

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