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**

Please let me know in case you have any queries and I will be happy to assist you.

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