Question

QUESTION THREE A. A company is considering two alternative investment projects both of which have a positive net present value. The projects have been ranked on the basis of both net present value (NPV) and internal rate of return (IRR). The result of the ranking is shown below: Project A Project B NPV Ist 2nd IRR 2nd 1st Discuss any four (4) potential reasons why the conflict between the NPV and IRR ranking may have arisen. (12 marks) B. Kumi Ltd is considering an investment in a project, which requires an immediate payment of GHS15,000, followed by a further investment of GHS5,400 at the end of the first year. The subsequent return phase net cash inflows are expected to arise at the end of the following years: Year 1 2 3. 5 Cash inflow (GHS) 6,500 7,750 5,750 4,750 3,750 You are required to estimate the internal rate of return of this project assuming the company's cost of capital of 16%. (18 marks) (Total: 30 marks) 4

Answer 1

1. Reasons as to why there are potential conflicts between NPV and IRR:

a. If there is significant difference in the amount (size) of cash outflow of both projects under consideration.

b. If there is a difference in cash flow patterns or timing of cashflows.

c. If the service life of project is different that is unequal project lives.

d. If there are non normal cash flows that is projects having large cash outflows at the end of the project.

2.

Year	Cashflows
-	-15,000
1	1,100	(6,500 - 5,400)
2	7,750
3	5,750
4	4,750
5	3,750
IRR	15.47%

As IRR is less than cost of capital of 16%, hence project is not recommended.

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