Question

Two projects being considered by a firm are mutually exclusive and have the following projected cash flows:

     Year                               Project A                       Project B

                                            Cash Flow                     Cash flow

       0                                      (2000)                            (2000)

       1                                         0                                     832

       2                                         0                                     832

       3                                         0                                     832

       4                                       3877                                 832                                 

Based only on the information given, which of the projects would be preferred and why?

Mark the correct answer but justify your answer showing your computations.

a.Project A, because it has a shorter payback period

b.Project B, because it has a higher IRR

c.Indifferent , because the projects have equal IRRs

d.Include both in the capital budget, since the sum of the cash inflows exceeds the initial investment in both cases.

e.Choose neither, since their NPVs are negative.

Answer 1

IRR of A=IRR({-2000;0;0;0;3877})=18.00%

IRR of B=IRR({-2000;832;832;832;832})=24.01%

b.Project B, because it has a higher IRR

e.Choose neither, since their NPVs are negative. [For this option we need the discount rate..If the discount rate is not given, Choose Option B otherwise if the discount rate is given and you forgot to provide the rate, substitute the discount rate in r below and see whether NPV of both are negative. If this is correct, then choose Option E]
NPV of A=-2000+3877/(1+r)^4
NPV of B=-2000+832/r*(1-1/(1+r)^4)