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