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	$878.96	$260	$10	$10
Project L	-$1,000	$0	$260	$420	$745.01

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)

=878.96/1.105+260/1.105^2+10/1.105^3+10/1.105^4
=$1022.49

NPV=Present value of inflows-Present value of outflows

=$1022.49-$1000

=$22.49(Approx).

L:

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

=260/1.105^2+420/1.105^3+745.01/1.105^4
=$1023.93

NPV=Present value of inflows-Present value of outflows

=$1023.93-$1000

=$23.93(Approx).

Hence L must be selected having higher NPV.

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

1000 =260/1.0x^2+420/1.0x^3+745.01/1.0x^4

Hence x=irr=11.3%(Approx).