Question

You have just started your summer​ internship, and your boss asks you to review a recent analysis that was done to compare three alternative proposals to enhance the​ firm's manufacturing facility. You find that the prior analysis ranked the proposals according to their​ IRR, and recommended the highest IRR​ option, Proposal A. You are concerned and decide to redo the analysis using NPV to determine whether this recommendation was appropriate. But while you are confident the IRRs were computed​ correctly, it seems that some of the underlying data regarding the cash flows that were estimated for each proposal was not included in the report. For Proposal​ B, you cannot find information regarding the total initial investment that was required in Year 0. And for Proposal​ C, you cannot find the data regarding additional salvage value that will be recovered in Year 3. Here is the information you have​(in $​ millions):

IRR Proposal Year 0 Year 1 Year 2 Year 3 60.0% A -$100 $30 $153 $88 58.8 % $0 $206 $95 C 59.5% -$100 $37 $0 $204 a. Fill in the missing values. b. Suppose the appropriate cost of capital for each alternative is 10%. Using this information, determine the NPV of each proposal. Which project should the firm choose? c. Can the IRR rule be used in this situation? Justify

Answer 1

B:
Cash flow for Year 0=-(0/1.588+206/1.588^2+95/1.588^3)=-105.4126341

C:
Cash flow for Year 3=(100-37/1.595-0/1.595^2)*1.595^3=311.6431
hence, question mark=311.6431-204=107.6431

NPV of A=-100+30/1.1+153/1.1^2+88/1.1^3=119.83

NPV of B=-105.4126341+0/1.1+206/1.1^2+95/1.1^3=136.21

NPV of C=-100+37/1.1+0/1.1^2+311.6431/1.1^3=167.78

Choose Project C

No IRR rule cannot be used in this situation because of size and timing differences