Barr, Inc. has a 20% required rate of return. Three managers have presented three potential projects...
Barr, Inc. has a 20% required rate of return. Three managers have presented three potential projects to increase income over the next ten years, each with their preferred measure. Project A was reported to have an NPV of $(2,460). Project B was reported with an IRR of 28%. Project C was reported to have a payback period of 23 years. With which of these projects should Barr move forward?
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All three sound great! |
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Project B |
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Project C |
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Project A |
Homework Answers
Sol:
PROJECT - B with an IRR of 28% should be
selected.
The reason behind selecting PROJECT - B & rejecting PROJECT - A
& C are as follows :-
1) In order to make a decision based on IRR method, first of all the business has to determine a minimum rate of return, that is called the CUT OFF RATE/ HURDLE RATE. A particular project can only be accepted if the IRR is greater than the Cut off rate, otherwise rejected. In our given problem, since the minimum required rate of return is 20% (given in question), so the project with rate of return more than the minimum rate should be selected. And as the IRR of Project B is 28%, so this project is selected whereas, Project A & C got rejected.
2) The IRR method takes into account the time value of money. Hence the cash flow occuring at different point are adjusted for time value of money.
3) PROJECT A got rejected because, when we are considering any project on basis of NPV method, it can only be selected when the Net Present Value of Cash Inflows is Positive & here since the NPV was $ (2460), so it got rejected, as negative cash inflows depicts losses in overall project.
4) PROJECT C was rejected because when we are judging any
Project on Pay Back Period method, the Pay Back Period should be
least & below if any cut off period is mentioned in question.
And in our problem a time frame of 10 years was mentioned &
this project took 23 years, which was far beyond the given
timeline. So it also got rejected &
Finally PROJECT B was selected over PROJECT A & PROJECT C, as
it gave more return than required by the business.
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