Question

A company is analyzing two mutually exclusive projects, S and L, with the following cash flows:

0

1

2

3

4

Project S	-$1,000	$888.85	$240	$15	$10
Project L	-$1,000	$5	$250	$420	$826.10

The company's WACC is 8.5%. What is the IRR of the better project? (Hint: The better project may or may not be the one with the higher IRR.) Round your answer to two decimal places.

  %

Answer 1

S:

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=888.85/1.085+240/1.085^2+15/1.085^3+10/1.085^4

=1042.05

NPV=Present value of inflows-Present value of outflows

=1042.05-1000

=$42.05(Approx)

L:

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=5/1.085+250/1.085^2+420/1.085^3+826.10/1.085^4

=1141.89

NPV=Present value of inflows-Present value of outflows

=1141.89-1000

=$141.89(Approx)

Hence L is better having higher NPV

Let irr be x%
At irr,present value of inflows=present value of outflows.

1000 =5/1.0x+250/1.0x^2+420/1.0x^3+826.10/1.0x^4

Hence x=irr=12.93%(Approx)