Question

If an independent project with conventional, or normal, cash flows is being analyzed, the net present value (NPV) and internal rate of return (IRR) methods agree. Projects W and X are mutually exclusive projects. Their cash flows and NPV profiles are shown as follows. NPV (Dollars) 800 0 -$1,00 Year Project W -$1,000 1 $200 2 $350 $400 $600 Project x -$1,500 $350 $500 $600 $750 Project X Project W If the weighted average cost of capital (WACC) for each project is 6%, do the NPV and IRR methods agree or conflict? -200 The methods agree. The methods conflict. 0 2 4 6 8 10 12 14 16 18 20 COST OF CAPITAL (Percent)

Answer 1

If an Independent project with conventional, or normal, cash flows is being analyzed, the net present value and internal rate of return methods will always agree.

Project W

Net present value can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$1,000.It is indicated the initial cash flow by a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the weighted average cost of capital of 6%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value is $311.28.  

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$1,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of project is 16.85%.

Project X

Net present value can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$1,500.It is indicated the initial cash flow by a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the weighted average cost of capital of 6%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value is $373     

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$1,500. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of project is 15.16%.

Project X should be accepted according to the net present value since it has the highest net present value.

Project W should be accepted according to the internal rate of return since it has the highest internal rate of return.

Therefore, the methods conflict.

The NPV calculation implicitly assumes that intermediate cash flows are reinvested at the weighted average cost of capital and the IRR calculation assumes that the rate at which can be reinvested is the internal rate of return.

As a result, when evaluating mutually projects, the net present value is usually the better decision criterion.

In case of any query, kindly comment on the solution.