Question

Choosing Between two Mutually Exclusive Projects Question 2: A company can cither invest in project A, project B, or neither (the projects are mutually exclusive and the company has no other investment options). Project A requires an initial investment of $1,000,000 and provides cash flows of $300,000 a year for six years. The project will also return $200,000 in capital back to the company in year six. Project B requires a $375,000 investment and will have cash flows of $200,000 a year for 4 years. The firm's hurdle rate for these projects is 8%. a) Which project, if any, should be chosen? b) Is the IRR of project A over 8%, below 8%, or exactly 8% c) Is the IRR of project B over 8%, below 8%, or exactly 8%? d) Which project has the higher IRR? How do you know?

Answer 1

B13 fx EIRR(B3:39) C в E 1 2 3 Initial outlay 4 Cash flows Year 1 5 Year 2 6 Year 3 7 Year 4 8 Year 5 9 Year 6 10 11 rate 12 13 IRR Project A -1000000 300000 300000 300000 300000 300000 500000 Project B -375000 200000 200000 200000 200000 8% 22% 39% 14

a. Project B is selected as IRR is greater than the hurdle rate which the minimum rate required and project A.
b. IRR for project A is 22%, above hurdle rate

c. IRR for project B is 39%, hurdle rate

d. IRR is calculated using Excel spreadsheet model, the formula to calculate IRR is given by equating NPV to zero

NPV= 0=CF₀ + CF₁ / (1+IRR)¹ + CF2 / (1+IRR)² + ....+​CFN / (1+IRR)^N

Please note the question has been answered considering only the IRR assuming no conflict exists NPV and IRR, since the question does not mention to verify with NPV.