Question

Problem 11-12
IRR and NPV

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	$894.25	$250	$5	$10
Project L	-$1,000	$5	$260	$400	$787.74

The company's WACC is 8.0%. 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

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

S:

Present value of inflows=894.25/1.08+250/1.08^2+5/1.08^3+10/1.08^4

=$1053.66

NPV=Present value of inflows-Present value of outflows

=$1053.66-$1000

=$53.66

L:

Present value of inflows=5/1.08+260/1.08^2+400/1.08^3+787.74/1.08^4

=$1124.08

NPV=Present value of inflows-Present value of outflows

=$1124.08-$1000

=$124.08(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+260/1.0x^2+400/1.0x^3+787.74/1.0x^4

Hence x=irr=11.90%(Approx).