Question

A company is analyzing two mutually exclusive projects, S and L, with the following cash flows:

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1

2

3

4

Project S	-$1,000	$892.99	$240	$15	$15
Project L	-$1,000	$10	$250	$400	$779.50

The company's WACC is 10.0%. 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.

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Answer 1

Better project is the one that has higher NPV

Project S:

NPV = Present value of cash inflows - present value of cash outflows

NPV = -1000 + 892.99 / (1 + 0.1)¹ + 240 / (1 + 0.1)² + 15 / (1 + 0.1)³ + 15 / (1 + 0.1)⁴

NPV = $31.67

Project L:

NPV = Present value of cash inflows - present value of cash outflows

NPV = -1000 + 10 / (1 + 0.1)¹ + 250 / (1 + 0.1)² + 400 / (1 + 0.1)³ + 779.5 / (1 + 0.1)⁴

NPV = $48.64

Project L is the better project.

IRR is the rate of return that makes NPV equals to 0

NPV = -1000 + 10 / (1 + R)¹ + 250 / (1 + R)² + 400 / (1 + R)³ + 779.5 / (1 + R)⁴

Using trial and error method, i.e., after trying various values for R, lets try R as 11.60%

NPV = -1000 + 10 / (1 + 0.116)¹ + 250 / (1 + 0.116)² + 400 / (1 + 0.116)³ + 779.5 / (1 + 0.116)⁴

NPV = 0

Therefore, IRR of better project is 11.60%