Question

eBook Problem Walk-Through A company is analyzing two mutually exclusive projects, S and L, with the following cash flows: 0 1 2 3 4 Project S - $1,000 $899.04 $240 $ 10 $5 Project L - $1,000 $10 $260 $420 $753.80 The company's WACC is 8.5%. What is the IRR of the better project? (Hint: The better project may or may not be the one with the higher IRR.) Round your answer to two decimal places. 0

Answer 1

Explaination:-
Internal rate of return is the rate where NPV of the project is zero. To calculate IRR, we should set NPV is equal to zero and solve for discount rate which is the IRR.
Using trial and error method we guessed the discounting rate for Project S to be 12.40% and 11.80% for Project L.

Project S
Year	Cashflows (in $)	PV of Cashflows @ 12.40%	PV of Cashflows @ 8.5%
0	-1000	-1000	-1000.00
1	899.04	799.86	828.61
2	240	189.97	203.87
3	10	7.04	7.83
4	5	3.13	3.61
	NPV	0.00	43.91
IRR of Project S is 12.40%
Project L
Year	Cashflows (in $)	PV of Cashflows @ 11.80%	PV of Cashflows @ 8.5%
0	-1000	-1000.00	-1000
1	10	8.94	9.216589862
2	260	208.01	220.8583746
3	420	300.55	328.8214013
4	753.80	482.49	543.9226955
	NPV	0.00	102.82
IRR of Project L is 11.80%

Decision on better project:-  
  
On the basis of IRR= Project S  
On the basis of NPV= Project L  
On the basis of payback period= Project A (as the payback period is less than the payback period of S because in Project S major chunk of the cashflow is arising at Year 4)