Question

Firm AAA has identified the following two mutually exclusive projects:

   

Year	Cash Flow (A)				Cash Flow (B)
0	–$	29,500			–$	29,500
1		14,900				4,550
2		12,800				10,050
3		9,450				15,700
4		5,350				17,300

1. At what discount rate would the company be indifferent between these two projects?

2. Which project will be more favorable if the firm can’t raise the money at this rate?

Please use financial calculator sovle question

Answer 1

1: We first compute the difference in cash flows of the two projects

Year	Cash Flow (A)	Cash Flow (B)	Difference
0	-29,500	-29,500	0
1	14,900	4,550	10,350
2	12,800	10,050	2,750
3	9,450	15,700	-6,250
4	5,350	17,300	-11,950

Enter these as cash flows CF0 = 0, CF1=10350, CF2 = 2750, CF3 = -6250, CF3 = -11950

Find IRR as 14.41%

This is the cross over rate.

b: We compute the IRR of each project separately.

Project A: Enter the cash flows in the calculator. Find IRR as 19.69%

Project B: Enter the cash flows in the calculator. Find IRR as 18.07%

Project A will be more profitable if the capital is not raised at 14.41%