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	$869.52	$250	$15	$10
Project L	-$1,000	$0	$260	$400	$780.94

The company's WACC is 9.5%. 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)

=869.52/1.095+250/1.095^2+15/1.095^3+10/1.095^4

=1020.97

NPV=Present value of inflows-Present value of outflows

=1020.97-1000

=$20.97(Approx)

L:

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

=260/1.095^2+400/1.095^3+780.94/1.095^4

=1064.71

NPV=Present value of inflows-Present value of outflows

=1064.71-1000

=64.71(Approx)

Hence L is better having higher NPV.

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

1000=260/1.0x^2+400/1.0x^3+780.94/1.0x^4

Hence x=irr=11.6%(Approx).