Question

You are deciding between two mutually exclusive investment opportunities. Both require the same initial investment of

$9.6 million. Investment A will generate

$2.08 million per year (starting at the end of the first year) in perpetuity. Investment B will generate

$1.53 million at the end of the first year, and its revenues will grow at

2.6% per year for every year after that.

a. Which investment has the higher

IRR?

b. Which investment has the higher NPV when the cost of capital is

7.5%?

c. In this case, when does picking the higher IRR give the correct answer as to which investment is the best opportunity?

Answer 1

You are deciding between two mutually exclusive investment opportunities. Both require the same initial investment of $30 million. Investment A will generate annual cash flows of $4 million beginning one year from now and continuing in perpetuity. Investment B will generate a cash flow of $3 million one year from now every year thereafter it will generate a cash flow that is 3% bigger than the prior cash flow. Assuming that both projects have the same cost of capital, at what cost of capital will you be indifferent between the two projects? Enter your answer as a percent without the “%”; round your final answer to two decimals.