Question

4. Project S has a cost of $10,000 and is expected to produce cash flows of $3000 per year for 5 years. Project L has a cost of $25,000 and is expected to produce cash flows of $7400 for 5 years. Calculate the NPV and IRR of the two projects assuming a cost of capital of 12%. Which project would you select, assuming they are mutually exclusive, using each ranking method?

Answer 1

Project S

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$10,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the cost of capital of 12%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 12% cost of capital is $814.33.

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$10,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of project is 15.24%.

Project L

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$25,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the cost of capital of 12%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 12% cost of capital is $1,675.34.

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$25,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of project is 14.67%.

I would select Project L since it has the highest net present value.

In case of any query, kindly comment on the solution.