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	$886.61	$260	$5	$10
Project L	-$1,000	$5	$260	$420	$724.69

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)

=886.61/1.09+260/1.09^2+5/1.09^3+10/1.09^4

=$1043.19

NPV=Present value of inflows-Present value of outflows

=$1043.19-$1000

=$43.19(Approx).

L:

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

=5/1.09+260/1.09^2+420/1.09^3+724.69/1.09^4

=$1061.13

NPV=Present value of inflows-Present value of outflows

=$1061.13-$1000

=$61.13(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+260/1.0x^2+420/1.0x^3+724.69/1.0x^4

Hence x=irr=11%(Approx).