Question

Consider two mutually exclusive R&D projects that Savage Tech is considering. Assume the discount rate for both projects is 13 percent.

Project A: |
Server CPU .13 micron processing project |

By shrinking the die size to .13 micron, the company will be able to offer server CPU chips with lower power consumption and heat generation, meaning faster CPUs. |

Project B: |
New telecom chip project |

Entry into this industry will require introduction of a new chip for cell phones. The know-how will require a large amount of up-front capital, but success of the project will lead to large cash flows later on. |

Year |
Project A |
Project B |
||||

0 |
–$ |
-715,000 |
–$ |
-921,000 |
||

1 |
342,000 |
257,000 |
||||

2 |
358,000 |
363,000 |
||||

3 |
256,000 |
362,000 |
||||

4 |
181,000 |
413,000 |
||||

5 |
122,000 |
498,000 |
||||

Complete the following table: **(Do not round intermediate
calculations. Enter the IRR as a percent. Round your profitability
index (PI) answers to 3 decimal places, e.g., 32.161, and other
answers to 2 decimal places, e.g., 32.16.)**

Project A |
Project B |
||||

NPV |
$ |
$ |
|||

IRR |
% |
% |
|||

PI |
|||||

What is the incremental IRR of investing in the larger project?
**(Do not round intermediate calculations. Enter your answer
as a percent and round your answer to 2 decimal places, e.g.,
32.16.)**

Incremental IRR _______%

Answer #1

Year | Project A | PV @ 13% |

0 | -715000 | -715,000.00 |

1 | 342000 | 302,654.87 |

2 | 358000 | 280,366.51 |

3 | 256000 | 177,420.84 |

4 | 181000 | 111,010.69 |

5 | 122000 | 66,216.71 |

NPV 222,670.62

IRR 27.639%

PI = Present value of Cash flow / Initail Investment

= 937669.62 / 715000 = 1.311

Year | Project B | PV @ 13% |

0 | -921,000.00 | -921,000.00 |

1 | 257,000.00 | 227,433.63 |

2 | 363,000.00 | 284,282.25 |

3 | 362,000.00 | 250,884.16 |

4 | 413,000.00 | 253,300.63 |

5 | 498,000.00 | 270,294.45 |

NPV 365,195.12

IRR 26.639%

PI = 1,286,195.12 / 921,000 = 1.396

Year | Project A | Project B | Incremental Cash Flow |

0 | -715000 | -921,000.00 | -206,000.00 |

1 | 342000 | 257,000.00 | -85,000.00 |

2 | 358000 | 363,000.00 | 5,000.00 |

3 | 256000 | 362,000.00 | 106,000.00 |

4 | 181000 | 413,000.00 | 232,000.00 |

5 | 122000 | 498,000.00 | 376,000.00 |

Incremental IRR = 25.1953

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Tech is considering. Assume the discount rate for both projects is
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heat generation, meaning faster CPUs.
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