Question

Bumble's Bees, Inc., has identified the following two mutually exclusive projects: Cash Flow (A) Cash Flow (B) Year 0 17,000 8,000 7,000 5,000 3,000 17,000 2,000 5,000 4 What is the IRR for each of these projects? If you apply the IRR decision rule, which project should the company accept? Is this decision necessarily correct? If the required return is 11%, what is the NPV for each of these projects? which project will you choose if you apply the NPV decision rule? Over what range of discount rates would you choose Project A? Project B? At what discount rate would you be indifferent between these two projects? 9,500 a. b. c.

PLEASE SHOW WORK AND CALCULATIONS THANKS

Answer 1

Calculate the IRR and NPV and cross over rate as follows:

Cashflow A Cash flow B Incremental cash flow Year PVF @ 11% Amount PV of amount Amount PV of amount Amount 1.0000 -$17,000.00-$17,000.00 0.9009 $8,000.00$7,207.21 0.8116$7,000.00$5,681.36 0.7312 $5,000.00$3,655.96 0.6587 $3,000.00$1,976.19 15.86% -$17,000.00-$17,000.00 $2,000.00$1,801.80 5,000.00$4,058.11 $9,000.00 $6,580.72 $9,500.00$6,257.94 $0.00 -$6,000.00 $2,000.00 $4,000.00 $6,500.00 4 IRR 14.69% As per IRR rule Cash flow A shall be selected, Because of highiest IRR 10 But, for mutually exclusive projects, IRR rule doesnt work good. For Mutually exclusive projects NPV rule is good. NPV As per NPV rule, Cash flow B shall be selected, because of heghiest NPV $1,698.58 12 b 13 14 C 15 16 $1,520.71 Cross over rate or idifferent rate More than 12.18% Less than 12.18% 12.18% Range for A Range for B

Formulas:

1 Cashflow A Cash flowB Incremental cash flow PV of amount Amount C3 D3 C4* D4 -C5 D5 C6*D6 C7 D7 PV of amount Amount C3*F3 C4*F4 C5*F5 -C6 F6 C7*F7 2 Year PVF @ 11% -1/(1+11%) ^ B3-17000 -1/(1+11%)^84 |8000 -1/(1+11%)ng5 |7000 -1/(1+11%)ng6 |5000 -1/(1+11%)ng7 3000 Amount 4 1 5 2 6 3 7 4 17000 2000 5000 9000 9500 IRR(F3:F7) -F3-D3 -F4-D4 -F5-D5 -F6-D6 F7-D7 IRR As per IRR rule Cash flow A shall be selected, Because of highiest IRR -RR(D3:D7) | 10 But, for mutually exclusive projects, IRR rule doesnt work good. For Mutually exclusive projects NPV rule is good. NPV As per NPV rule, Cash flow B shall be selected, because of heghiest NPV SUM(E3:E7) SUM(G3:G7) 12 b 13 14 c 15 16 Cross over rate or idifferent rate More than 12.18% Less than 12.18% IRR(H3:H7) Range for A Range for B