Question

14. Suppose two mutually exclusive projects ABC and XYZ one could invest in. Both projects would require an initial investment of $750,000. Project ABC has a one-time cash flow next year of $500,000 whereas project XYZ is characterized by a cash flow of $100,000 next year. The cash flow will then continue to grow forever at a fixed rate of 2%. The incremental IRR for this project pair comes closest to: A) 24.5% B) 25.5% C) 26.5% D) 27.5% Ans: D

Answer 1

Solution :-

In year 0 , As initial investment of both projects are equal Therefore there is no incremental Cash flows.

Year 1 incremental Cashflow = Cash inflow of XYZ - Cash flow of ABC =

= $100,000 - $500,000 = - $400,000

Now a year 2

Incremental cashflows = Cash inflow of XYZ = $100,000 * ( 1+0.02) = $102, 000

And Year 3 = $102, 000 * (1+0.02) = $104,040

Similiarily forver

Now assume incremental IRR be r

$400,000 = $102,000/( r - 0.02 )

( r - 0.02 ) = 0.255

r = 0.275 = 27.5%

Therefore correct answer is (d)

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