Question

P 8-28 (similar to) Question Help You are choosing between two projects. The cash flows for the projects are given in the following table ($ million): Project Year 0 - $51 - $102 Year 1 $23 $20 Year 2 $22 $42 Year 3 $22 $48 Year 4 $16 $61 a. What are the IRRs of the two projects? b. If your discount rate is 4.8%, what are the NPVs of the two projects? c. Why do IRR and NPV rank the two projects differently? a. What are the IRRs of the two projects? The IRR for project A is %. (Round to one decimal place.)

Answer 1

a. The IRR of the Project A is :

CF0 = ($51)

CF1= $23

CF2 = $22

CF3= $22

CF4= $16

($51) + $23/ (1 + irr)^1 + $22/(1+ irr)^2 + $22/(1 + irr)^3 + $16/(1+ irr)4 = 0

So, the IRR of project A is 24.2% ( rounded off to one decimal place)

Similarly, the IRR for project B is 20.5% ( rounded off to one decimal place)

b. The discount rate is 4.8%. the NPV of Project A is :

= ($51) + $23/1.048^1 + $22/(1.048)^2 + $22/(1.048)^3 + $16/(1.048)^4

= $23.4 ( rounded off to one decimal place)

Simiallry. the NPV of Proejct B is :

= $47.6  ( rounded off to one decimal place)

The difference in the reinvestment between the two methods is the reason behind the different rankings of the two projects. The NPV assuems that cash flow is reinvested at the cost of capital and the IRR assumes that the cash flow is reinvested at the IRR. Hence, the difference in the rankings of the two projects.