Question

A company has the following investment alternatives. The cash flows are shown below. Year Project A Project B 0 -$2,000 -$2,000 1 900 1,100 2 800 800 3 700 500 Which project(s) should the company select if the cost of capital is 11%?

Project A with an IRR of 12.37%

Project B with an IRR of 17.69%

Project A with an IRR of 10.16%

Project B with an IRR of 11.19%

Both project A and project B

Answer 1

Ans Project A with an IRR of 10.16%

We should select the project which has IRR less than cost of capital.

PROJECT A Project Cash Flows (i) DF@ 10% DF@ 10% (ii) Year -2000 900 800 700 1/((1+10%)^1) 1/((1+10%)^2) 1/((1+10%)^3) 0.909091 0.826446 0.751315 PV of Project ( (i) * (ii)) DF@ 20% PV of Project (i) * (iii)) (2,000.00) 1 (2,000.00) 818.18 0.833 750.00 661.16 0.694 555.56 525.92 0.579 405.09 5.26 NPV (289.35) NPV IRR = Ra + NPVa/ (NPVA - NPVb) * (Rb - Ra) 10% +5.26 / (5.26 + 289.35)*10% 10.16%

PROJECT B Project Cash Flows (i) DF@ 10% DF@ 10% (ii) Year -2000 1100 800 500 1/((1+10%)^1) 1/((1+10%)^2) 1/((1+10%)^3) 0.909091 0.826446 0.751315 PV of Project ( (i) * (ii)) DF@ 20% PV of Project (i) * (iii)) (2,000.00) 1 (2,000.00) 1,000.00 0.833 916.67 661.16 0.694 555.56 375.66 0.579 289.35 36.81 NPV (238.43) NPV IRR = Ra + NPVa/ (NPVA - NPVb) * (Rb - Ra) 10% + 36.81 / (36.81 +238.43)*10% 11.19%