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 $880.62 $250 $10 $15 Project L -$1,000 $5 $260 $420 $729.15 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

S:

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

=880.62/1.1+250/1.1^2+10/1.1^3+15/1.1^4

=$1024.93

NPV=Present value of inflows-Present value of outflows

=$1024.93-$1000

=$24.93(Approx).

L:

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

=5/1.1+260/1.1^2+420/1.1^3+729.15/1.1^4

=$1032.99

NPV=Present value of inflows-Present value of outflows

=$1032.99-$1000

=$32.99(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+260/1.0x^2+420/1.0x^3+729.15/1.0x^4

Hence x=irr=11.1%(Approx).