Question

Problems 1-2 are based on the information given in the following table:

Year	A	B
0	-2,500	-6,000
1	746	1,664
2	746	1,664
3	746	1,664
4	746	1,664
5	746	1,664
IRR	15%	12%

The internal rate of return on the incremental cash flows is closest to _________.

	A.	4%
	B.	6%
	C.	8%
	D.	10%
	E.	12%

Based on the information in the previous Problem #1, if only one project can be undertaken and the company's management requires a MARR of 8% on all new investment projects, which alternative do you recommend?

	A.	A
	B.	B
	C.	Both projects are equally worthwhile
	D.	Neither project should be undertaken
	E.	I'm lost so I say flip a coin

Answer 1

1. The correct option is D.

The incremental cashflow, with IRR, is shown below.

Year B Incremental 0 A -2,500 746 746 -3,500 918 1 2 918 3 746 -6,000 1,664 1,664 1,664 1,664 1,664 11.99% 4 746 918 918 918 9.78% 5 746 IRR 15.01%

The incremental cashflow has been calculated by B-A. The IRR has been calculated by the formula =IRR(cashflows).

2. The NPVs for both projects are shown below. Explanation follows.

Year 0 Incremental -3,500 918 1 2 918 3 A B -2,500 -6,000 746 1,664 746 1,664 746 1,664 746 1,664 746 1,664 15.01% 11.99% 478.56 643.87 918 4 918 5 IRR NPV 918 9.78% 165.31

NPV has been calculated by the formula =NPV(MARR,cashflows)+Initial Investment.

NPV can also be calculated manually by the formula-

Cash flow NPV initial investment (1+i) where: i= Required return or discount rate t = Number of time periods

As we can see, the higher NPV is of alternative A, hence it should be chosen.

So, Option A is the right answer.