Question

please show full steps of the solution for full credit. not excel solutions please. thank you!!!

9. The Ott Group, Inc., has identified the following two mutually exclusive projects: Year 0 Cash Flow (S) - $12,500 4,000 5,000 6,000 1,000 Cash Flow (L) - $12,500 1,000 6,000 5,000 4,000 a. What is the IRR for each of these projects? If you apply the IRR decision rule, which project should the company accept? b. If the required return is 11 percent, what is the NPV for each of these projects? Which project will you choose if you apply the NPV decision rule?

Answer 1

a)

Project S:

IRR is the rate of return that makes initial investment equal to present value of cash inflows

12500 = 4000 / (1 + r)¹ + 5000 / (1 + r)² + 6000 / (1 + r)³ + 1000 / (1 + r)⁴

Using trial and error method, i.e., after trying various values for R, let try R as 11.85%

12500 = 4000 / (1 + 0.1185)¹ + 5000 / (1 + 0.1185)² + 6000 / (1 + 0.1185)³ + 1000 / (1 + 0.1185)⁴

12500 = 12500

Therefore, IRR of project S is 11.85%

Project L:

IRR is the rate of return that makes initial investment equal to present value of cash inflows

12500 = 1000 / (1 + r)¹ + 6000 / (1 + r)² + 5000 / (1 + r)³ + 4000 / (1 + r)⁴

Using trial and error method, i.e., after trying various values for R, let try R as 9.53%

12500 = 1000 / (1 + 0.0953)¹ + 6000 / (1 + 0.0953)² + 5000 / (1 + 0.0953)³ + 4000 / (1 + 0.0953)⁴

12500 = 12500

Therefore, IRR of project L is 9.53%

Project S should be accepted as it has the higher IRR

b)

Project S:

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

NPV = -12500 + 4000 / (1 + 0.11)¹ + 5000 / (1 + 0.11)² + 6000 / (1 + 0.11)³ + 1000 / (1 + 0.11)⁴

NPV = $207.60

Project L:

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

NPV = -12500 + 1000 / (1 + 0.11)¹ + 6000 / (1 + 0.11)² + 5000 / (1 + 0.11)³ + 4000 / (1 + 0.11)⁴

NPV = -438.48

Project S should be accepted as it has a positive NPV