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   $910.23   $240   $5   $5
Project L   -$1,000   $5   $240   $420   $823.16
The company's WACC is 9.0%. 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

S:

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

=910.23/1.09+240/1.09^2+5/1.09^3+5/1.09^4

=$1044.48

NPV=Present value of inflows-Present value of outflows

=$1044.48-$1000

=$44.48(Approx).

L:

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

=5/1.09+240/1.09^2+420/1.09^3+823.16/1.09^4

=$1114.05

NPV=Present value of inflows-Present value of outflows

=$1114.05-$1000

=$114.05(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+240/1.0x^2+420/1.0x^3+823.16/1.0x^4

Hence x=irr=12.6%(Approx).