Question

TE You work for an outdoor play structure manufacturing company and are trying to decide between the following two projects: Year-End Cash Flows ($ thousands) Project 0 1 2 IRR Playhouse (minor project) 16 22 27.8% Fort (major poject) - 79 40 51 9.6% ent - 26 - You can undertake only one project. If your cost of capital is 7%, use the incremental IRR rule to make the correct Rr decision rer The incremental IRR is %. (Round to two decimal places.) With the incremental IRR at 0.00% and the cost of capital of 7%, you should undertake the (Select from the drop-down menu.) from the drop-down menu)

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

A C D E Year ramon 1 Playhouse $26,000.00 $16,000.00 $22,000.00 27.8% Fort $79,000.00 $40,000.00 $51,000.00 9.6% Incremental CF -$53,000.00 $24,000.00 $29,000.00 0.0% Incremental IRR 0.00% Cost of capital 7% Undertake Playhouse FAMOFO Incremental IRR is less than Cost of capital thus, Project with higher intial cost is not beneficial. Therefore, undertake Project with lower initial cost i.e Playhouse.

Cell reference -

111 A B C D Year Fort Playhouse -26000 16000 22000 =IRR(C3:05) -79000 40000 51000 =IRR(D3:05) Incremental CF =D3-C3 =D4-C4 =D5-C5 =IRR(E3:E5) IRR Incremental IRR =E6 Cost of capital 0.07 12 Undertake Playhouse 13 14 15 Incremental IRR is less than Cost of capital thus, Project with higher intial cost is not beneficial. Therefore, undertake Project with lower initial cost i.e Playhouse. 16 17 18 19

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.