Question

NPV versus IRR Piercy, LLC, has identified the following two mutually exclusive projects: Year Cash Flow (A) Cash Flow (B) -$77,500 -$77,500 43,000 21,500 29,000 28,000 23,000 34,000 21,000 41,000 a. What is the IRR for each of these projects? If you apply the IRR decision rule, which project should the company accept? Is this decision necessarily correct? 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? c. Over what range of discount rates would you choose Project A? Project B? At what discount rate would you be indifferent between these two projects? Explain.

Answer 1

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Answer:

- X V fx =IRR(B3:37) 1 Year Cash flows 0 $ 1 $ 2 $ 31 S 4 $ 77,500) $ 43,000 $ 29,000 $ 23,000S 23.000 21,000 $ 77,500) $ 21,500 $ 28,000 $ 34,000 $ 41,000 $ D Difference Т . 21,500 1.000 (11,000) 20,000) E PVIF@11% c 1.000 $ 0.901 $ 0.812 $ 0.731 $ 0.659 $ F Present value Axc 77,500.00) $ 38,738.74 $ 23,537.05 $ 16,817.40 $ 13,833.35 $ Bхс (77,500.00) 19,369.37 22,725.43 24,860.51 27,007.97 IRR 21.50% 19.58% $ 15,426.54 $ 16,463.27 13.18% NPV (Indifference rate) 10

a)

12 a) Project A Project B 21.50% 19.58% Project A should be selected

The decision solely based on IRR must nor be taken as the company might want to maximize their earnings by taking into account the PV of the cash flows

b)

Project A Project B $ $ 15,426.54 16,463.27 Project B should be selected

c)

c) Project A for discount rates above 13.18% Project B for discount rates below 13.18% Discount rate 13.18%