Question

Mary Inc. is considering mutually exclusive Projects A and B, whose cash flows are shown below. If the decision is made by choosing the project with the higher IRR, will there be any value loss due to the IRR-based decision? If there is a loss, how much value will be forgone? The WACC is assumed to be 9.5%.

WACC: Year	9.5%	0	1	2	3	4
CFA		−$2,020	$730	$730	$740	$740
CFB		−$4,100	$1,400	$1,500	$1,520	$1,530

Answer 1

Using EXCEL's Goal Seek Function to solve for IRR (the WACC at which NPV is zero), we observe that Project A's IRR is greater (at 16.85 % ) and hence the same should be selected.

As is observable NPV (B) > NPV(A). This implies a loss in value if the IRR criterion is used to select the project, as Project A would be selected in such a case even though it has a lower NPV.

Value Loss = NPV(B) - NPV(A) = 651.5 - 333.84 = $ 317.65