Question

IRR—Mutually exclusive projects Bell Manufacturing is attempting to choose the better of two mutually exclusive projects for expanding the firm's warehouse capacity. The relevant cash flows for the projects are shown in the following table: . The firm's cost of capital is 12%. a. Calculate the IRR for each of the projects. Assess the acceptability of each project on the basis of the IRRs. b. Which project is preferred? 0 Data Table a. The internal rate of return (IRR) of project X is %. (Round to two decimal places.) (Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) e Initial investment (CF) Year (1) Project X Project Y $500,000 $280,000 Cash inflows (CF) $120,000 $140,000 $160,000 $100,000 $150,000 $75,000 $210,000 $50,000 $240,000 $50,000

Answer 1

a)

Project X:

IRR is the rate of return that makes initial investment equal to present value of cash inflows

500,000 = 120,000 / (1 + R)¹ + 160,000 / (1 + R)⁴ + 150,000 / (1 + R)³ + 210,000 / (1 + R)⁴ + 240,000 / (1 + R)⁵

Using trial and error method, i.e after trying various values for R, lets try R as 19.65%

500,000 = 120,000 / (1 + 0.1965)¹ + 160,000 / (1 + 0.1965)⁴ + 150,000 / (1 + 0.1965)³ + 210,000 / (1 + 0.1965)⁴ + 240,000 / (1 + 0.1965)⁵

500,000 = 500,000

Therefore, IRR of project X is 19.65%

Project y:

IRR is the rate of return that makes initial investment equal to present value of cash inflows

280,000 = 140,000 / (1 + R)¹ + 100,000 / (1 + R)⁴ + 75,000 / (1 + R)³ + 50,000 / (1 + R)⁴ + 50,000 / (1 + R)⁵

Using trial and error method, i.e after trying various values for R, lets try R as 18.73%

280,000 = 140,000 / (1 + 0.1873)¹ + 100,000 / (1 + 0.1873)⁴ + 75,000 / (1 + 0.1873)³ + 50,000 / (1 + 0.1873)⁴ + 50,000 / (1 + 0.1873)⁵

280,000 = 280,000

Therefore, IRR of project Y is 18.73%

2)

Project X should be accepted as it has the higher IRR