Question

AN INTERNAL RATE OF RETURN PROBLEM: NOW, REFER TO THE TABLE IN PROBLEM 6 ABOVE THE CASH FLOWS ASSUMED, INCLUDING THE INVESTMENT ARE NOW GIVEN IN THE TABLE BELOW FOR PROJECTS A AND B PROJECTA -1,000 450 425 350 450 PROJECTB -1,000 475 WHICH PROJECT WOULD YOU CHOOSE USING INTERNAL RATE OF RETURN ANALYSIS? BE SURE TO CHECK FOR CONSISTENCY OF THE INTERNAL RATES OF RETURN THAT YOU DERIVE FOR THESE PROJECTS, AND THE CONSISTENCY OF IRR WITH NET PRESENT VALUE INFORMATION WHY WOULD YOU MAKE THE CHECK FOR CONSISTENCY? PROBLEMS 1 & 21 PROBLEMS 3-8 PROBLEMS 9-11 | 就緒

Answer 1

Internal rate of return, IRR can be easily calculated using the IRR function built in excel.

IRR = IRR(C₀, C₁, C₂,....C_n) where C_i = Cash flow occurring at the end of year i

Now, please see the table below:

	Project A	Project B
	-1000	-1000
	450	550
	425	300
	350	475
	450	300
IRR	24.74%	24.88%

I have used the IRR function of excel and applied the formula in excel as IRR for project A = IRR (-1000, 450, 425, 350, 450) and that for project B as = IRR(-1000, 550, 300, 475, 300)

Between the two projects, IRR of Project B is marginally better than IRR of Project A. Hence, purely on the basis of IRR and if i have to choose just one of the two projects, I will choose Project B.

I will not be able to check the consistency of output based on IRR with that based on NPV because NPV information has not been provided in the screenshot.

We need to make the check for consistency, because in some cases of capital budgeting, selection of projects may differ under NPV method and IRR method. Therefore, consistency check is required. In case of inconsistency, our project selection should be based on NPV analysis.