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	$871.66	$250	$15	$5
Project L	-$1,000	$5	$260	$400	$753.16

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

NPV of Project S =[ 871.66*1/(1.09)^1+250*1/(1.09)^2+15*1/(1.09)^3+5*1/(1.09)^4]-1000

= $ 25.23

NPV of Project L =[ 5*1/(1.09)^1+260*1/(1.09)^2+400*1/(1.09)^3+753.16*1/(1.09)^4]-1000

= $ 65.85

Since the NPV of Project L is higher, it is the better project.

IRR of Project L:

Let the IRR be x.

Now , Present Value of Cash Outflows=Present Value of Cash Inflows

1,000 = 5/(1.0x) +260/ (1.0x)^2 +400/(1.0x)^3+ 753.16/(1.0x)^4      

Or x= 11.14%

Hence the IRR is 11.14%