Question

We have two mutually exclusive investments with the following cash flows:                                                                                                   (13 marks total)

Year	Investment A	Investment B
0	–$100	–$100
1	10	50
2	30	40
3	50	30
4	70	20

a.  Using a financial calculator, calculate the IRR for each of the investments. State your answers in percentages rounded to two decimal places.       (2 marks)

b.  Calculate the NPV profile for each investment, using the discount rates of 0%, 5%, 10%, 15%, 20%, and 25%. Perform this task in an Excel spreadsheet. Cautionary note: If you use the =NPV() function in Excel to calculate the NPVs, it will provide incorrect answers. The NPV() function actually calculates the present value of all cash inflows. The NPV should be calculated as =NPV(all cash inflows) – initial cash outflow.                                                       (2 marks)

c.  Plot the NPV profile for both projects using the X-Y scatter function in Excel.                                                                                                  (2 marks)

d.  If the required return on this project is 17%, would both NPV and IRR give us the same conclusion? Explain your answer.                                     (2.5 marks)

e.  If the required return on this project is 10%, would both NPV and IRR give us the same conclusion? Explain your answer.                                     (2.5 marks)

f.   Calculate the crossover rate at which we are indifferent between the two investments.                                                                   (2 marks)

Answer 1

a]

Investment A

CF₀ = -100

CF₁ = 10

CF₂ = 30

CF₃ = 50

CF₄ = 70

CPT -->> IRR

IRR is calculated to be 16.62%

Investment B

CF₀ = -100

CF₁ = 50

CF₂ = 40

CF₃ = 30

CF₄ = 20

CPT -->> IRR

IRR is calculated to be 17.80%

b]

c]

d]

As per NPV rule, project should be accepted if NPV is positive.

As per IRR rule, project should be accepted if IRR is higher than the required return

Investment A

NPV @ 17% is -$0.96. Project should be rejected

IRR is 16.62%. Project should be rejected

Investment B

NPV @ 17% is $1.36. Project should be accepted.

IRR is 17.80%. Project should be accepted.

Yes, both NPV and IRR give us the same conclusion