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	$872.40	$260	$15	$10
Project L	-$1,000	$10	$260	$400	$762.96

The company's WACC is 10.5%. 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)

=872.40/1.105+260/1.105^2+15/1.105^3+10/1.105^4

=1020.26

NPV=Present value of inflows-Present value of outflows

=1020.26-1000

=$20.26(Approx)

L:

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

=10/1.105+260/1.105^2+400/1.105^3+762.96/1.105^4

=1030.19

NPV=Present value of inflows-Present value of outflows

=1030.19-1000

=$30.19(Approx)

Hence L is better having higher NPV.

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

1000=10/1.0x+260/1.0x^2+400/1.0x^3+762.96/1.0x^4

Hence x=irr=11.51%(Approx).