Question

Kosovski Company is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and are not repeatable. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under some conditions choosing projects on the basis of the IRR will cause $0.00 value to be lost.

WACC:	6.25%
	0	1	2	3	4
CFS	-$1,050	$675	$650
CFL	-$1,050	$360	$360	$360	$360

a. $35.69

b. $29.26

c. $34.82

d. $26.33

e. $31.31

Answer 1

Present value of cash flow of Project S ÷

= 675(1+0.0625)¹ + 650(1+0.0625)² - 1,050

=675× 0.94117 + 650 × 0.88581 - 1,050

=635.28975 + 575.7765 - 1,050

=$161.06625

Present value of cash flow of Project L÷

= 360(1+0.0625)¹ + 360(1+0.0625)² + 360(1+0.0625)³ + 360(1+0.0625)⁴ - 1,050

=360 × 0.94117 + 360 × 0.88581 + 360 × 0.83371 + 360 × 0.78466 -  1,050

=338.8212 + 318.8916 + 300.1356 + 282.4776 - 1,050

=$190.326

The difference of both the NPV is

$(190.326 - 161.06625)

=$ 29.25975

=$29.26

The correct answer is option b. i.e. $29.26

NOTE ÷

As nothing mentioned in the question about rounding off, the present value annuity factor is rounded to 5 decimals. And the final answer to two decimals.