Question

IRR and NPV 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 $882.94 $240 $15 $10 Project L -$1,000 $5 $240 $380 $793.73 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)

=882.94/1.105+240/1.105^2+15/1.105^3+10/1.105^4

=$1013.42

NPV=Present value of inflows-Present value of outflows

=$1013.42-$1000

=$13.42(Approx).

L:

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

=5/1.105+240/1.105^2+380/1.105^3+793.73/1.105^4

=$1015.11

NPV=Present value of inflows-Present value of outflows

=$1015.11-$1000

=$15.11(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+380/1.0x^3+793.73/1.0x^4

Hence x=irr=11%(Approx).