Question

, A firm is evaluating the following two mutually exclusive, but quite profitable 2-year projects I and II, with cash flows at t0,1 and 2 as follows: Year t Project I Project II - $10,000 +20,000 +10,000 $10,000 +$40,000 Compute each project's NPV for r=0% and r=10%, where r= discount rate or required rate Based on the cash flow patterns for the two projects and the answer to part a), can we Using the analytical formulation of the intersection of the 2 curves, determine r, the value a) of return. Compute each project's IRR using the direct equation (you can verify using Excel). Rank the 2 projects l) according to NPV at r-10% and 2) according to IRR b) determine if these two projects will have a Fisher's intersection, i.e. if their NPV curves as a function of the discount rate r will intersect? c) of the discount rate r at the Fisher's intersection, and the NPV at r* for both projects. Comment on the significance of r, as a determinant of the areas/ranges of agreement-disagreement between NPV and IRR d) Using the results above, sketch the two NPV profiles (NPV curves as a function of r) for projects I and II

Answer 1

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Part (a)

Project 1 (Discount Rate is 10%)

CF0 = - 10000, CF1 = 0, CF2 = 40000 i = 10%

Therefore NPV = 23,058

Projects 1( If discount rate is 0%)

NPV = 30000 ie Cash Inflow minus Cash Outflow

Project 2 (if Discount rate is 10%)

CF0 = -10000, CF1 = 20000, CF2 = 10000, i = 10%

Then NPV = 16446.2

Project 2 ( If discount rate is 0%)

NPV = 20000 i.e. inflow minus Outflow ( 30000-10000)

Answer : Project 1 is better because it has Higher NPV