Question

Thomas Company is considering two mutually exclusive projects. The firm has a 12% cost of capital. Cash inflows Initial investment Year 1 Year 2 Year 3 Year 4 Year 5 Project A Project B $130000 $85000 $25000 $35000 $45000 $50000 $55000 $40000 $35000 $30000 $10000 $5000 Evaluate and discuss the rankings of NPV and IRR of the two projects on the basis of your finding. O A Project B should be chosen because it has a higher IRR than Project A. Based on the NPVs and IRRs, both projects should be accepted. c. Based on the NPV profile, Project B should be chosen D. Based on the NPV profile, Project A should be chosen.

Answer 1

Mutually exclusive projects are a set of projects out of which only one project should be selected.
The project with higher NPV or net present value should be selected because higher NPV will increase the shareholders' value by higher amount.
We can calculate the values of NPV and IRR using excel as;

From our calculations in excel, we see that;
NPV of project A = $15237.71
NPV of project B = $9161.79

Year Project A cash flows Project B cash flows - 130000 -85000 25000 40000 35000 35000 45000 30000 50000 10000 55000 5000 8 NPV= 15237.71 9161.79 9 Formula used: H2+NPV(12%,H3:47) 12+NPV(12%,13:17) 10 IRRE 16.06% 17.75% 11 Formula used: IRR(H2:H7) IRR(12:17)

IRR of project A = 16.06%
IRR of project B = 17.75%

Ranking as per NPV:
Rank 1: Project A
Rank 2: Project B

Ranking as per IRR:
Rank 1: Project B
Rank 2: Project A

As the project A has higher NPV and its IRR is greater than the cost of capital, it should be selected.

Answer: Option D is correct.