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	$889.30	$250	$10	$15
Project L	-$1,000	$10	$260	$420	$726.75

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)

=889.3/1.085+250/1.085^2+10/1.085^3+15/1.085^4

=$1050.65

NPV=Present value of inflows-Present value of outflows

=$1050.65-$1000

=$50.65(Approx).

L:

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

=10/1.085+260/1.085^2+420/1.085^3+726.75/1.085^4

=$1083.30

NPV=Present value of inflows-Present value of outflows

=$1083.30-$1000

=$83.30(Approx).

Hence L must be selected 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+420/1.0x^3+726.75/1.0x^4

Hence x=irr=11.2%(Approx).