Tesar Chemicals is considering Projects S and L, whose cash flows are shown belo

Question

Tesar Chemicals is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates the NPV. If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone, i.e., what's the chosen NPV versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. NPV will have no effect on the value gained or lost.

WACC: 8%

Year

0

1

2

3

4

CFS

-$1,500

$300

$400

$700

$800

CFL

-$2,200

$400

$700

$900

$1,100

$33.32

$29.07

$26.95

$23.51

$21.19

Year

0

1

2

3

4

CFS

-$1,500

$300

$400

$700

$800

CFL

-$2,200

$400

$700

$900

$1,100

Explanation / Answer

ar CFS CFL differential NPV OF differential 0 1.00 ($1,500) ($2,200) ($700) -700.00 1 0.93 $300 $400 $100 92.59 2 0.86 $400 $700 $300 257.20 3 0.79 $700 $900 $200 158.77 4 0.74 $800 $1,100 $300 220.51 14.47% 13.01% 29.07 Answer is 29.07

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