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	$874.19	$260	$5	$5
Project L	-$1,000	$0	$240	$400	$792.04

The company's WACC is 9.5%. 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)

=874.19/1.095+260/1.095^2+5/1.095^3+5/1.095^4

=$1022.48

NPV=Present value of inflows-Present value of outflows

=$1022.48-$1000

=$22.48(Approx).

L:

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

=240/1.095^2+400/1.095^3+792.04/1.095^4

=$1055.75

NPV=Present value of inflows-Present value of outflows

=$1055.75-$1000

=$55.75(Approx).

Hence L is better having higher NPV.

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

1000 =240/1.0x^2+400/1.0x^3+792.04/1.0x^4

Hence x=irr=11.3%(Approx).