Question

RR 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 $878.41 $240 $10 $15

Project L -$1,000 $5 $250 $400 $768.23

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)

=878.41/1.085+240/1.085^2+10/1.085^3+15/1.085^4

=$1032.12

NPV=Present value of inflows-Present value of outflows

=$1032.12-$1000

=$32.12(Approx).

L:

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

=5/1.085+250/1.085^2+400/1.085^3+768.23/1.085^4

=$1084.47

NPV=Present value of inflows-Present value of outflows

=$1084.47-$1000

=$84.47(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+400/1.0x^3+768.23/1.0x^4

Hence x=irr=11.2%(Approx).