Question

Consider two projects, A and B. Project A's first cash flow is $10,100 and is received three years from today. Future cash flows for Project A grow by 4 percent in perpetuity. Project B's first cash flow is −$8,800, which occurs two years from today, and will continue in perpetuity. Assume that the appropriate discount rate is 12 percent.

a. What is the present value of each project? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

	Present value
Project A	$
Project B	$

b. Suppose that the two project are combined into one project, called C. What is the IRR of Project C? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

IRR              %

c. What is the correct IRR rule for Project C?

• Accept the project if the discount rate is below the IRR.

• Accept the project if the discount rate is above the IRR.

• Accept the project if the discount rate is equal the IRR.

Answer 1

a)

Present value in case of Perpetuity

Project A = (Cash Flow of Year 3 * (1+ g))/(r-g)

=(10100*(1+.04))/(0.12-0.04)

=131300

Project B = -8800/0.12

=-73333.33

b) assuming there is a period of 10 years

IRR in Excel = 7%

ET STREET

c)

Accept the project if the discount rate is below the IRR.