Question

4. Farrah Corporation is considering two projects (see below). For your analysis, assume these projects are mutually exclusive with a required rate of return of 12%. Initial investment Cash inflow Year 1 Project 1 $185,000 $230,000 Project 2 $1,100,000 $1,450,000 Compute the following for each project: NPV (net present value) PI (profitability index) IRR (internal rate of return) Which project should be selected? Why?

Answer 1

Answer:

NPV, PI and IRR of both the projects are as below:

Cash flow Year 0 Cash flow Year 1 Project 1 Project 2 ($185,000) ($1,100,000) $230,000 $1,450,000 NPV PI IRR $20,357.14 $194,642.86 1.11 24.32% 31.82% 1.18

Project 2 should be selected. Project 2 has higher positive NPV and higher PI.

Working:

The above excel with 'show formula' is as below:

А Project 1 2 Cash flow Year 0 -185000 3 Cash flow Year 1 230000 Project 2 - 1100000 1450000 5 NPV 6 PI 7 IRR =NPV(12%,B3)+B2 =(B5-B2)/-B2 =IRR(B2:33) =NPV(12%,C3)+C2 =(C5-C2)/-C2 =IRR(C2:03) 8