2. NPV and IRR methods Ford Industries is evaluating two mutually exclusive proj

Question

2. NPV and IRR methods Ford Industries is evaluating two mutually exclusive projects with the following net ca5h flows: Project A ?$2,000 $300 $500 $800 $1,200 Project B ?$2,000 $1,000 $800 $500 $200 Ford?s WACC is 9.1% and both projects have the same risk as the firm?s average project. Calculate each project?s net present value (NPV). Ford?s CFO has instructed managers to use the IRR method when choosing between mutually exclusive projects. If managers choose the project with the highest IRR, how much value will be lost? (Hint: If the project with the highest IRR also has the highest NPV, then no value is lost because the firm selects the project that adds the most value. Otherwise, the difference between the two projects? NPVs is the value lost from u5ing the IRR method instead of the NPV method.) $43.20 $34.60 $22.05 $0.00 $38.87

Explanation / Answer

Net present value = Present value of cash inflows - Present value of cash outflows

Net present value project A = 158

Net present value project B = 115

IRR project A = 9.10%+3.03 i.e 12.13%

IRR project B = 9.10% +3.44 i.e 12.54%

If the project with highest NPV is accepted i.e project B then the NPV lost will be 43.20

Particulars Year PVF @ 9.1% PVF @ 15% Cash flow Project A Cash flow Project B PV Project A @9.1% PV Project B@9.1% PV Project A @ 15% PV Project B @ 15% Initial cash outflow 0 1 1 2000 2000 2000 2000 2000 2000 Present value of cash outflows 2000 2000 2000 2000 Cash inflows 1 0.9166 0.8696 300 1000                   275                917                261                870 Cash inflows 2 0.8401 0.7561 500 800                   420                672                378                605 Cash inflows 3 0.77 0.6575 800 500                   616                385                526                329 Cash inflows 4 0.7058 0.5718 1200 200                   847                141                686                114 Present value of cash inflows                2,158             2,115             1,851            1,918 Net Present value                   158                115               -149                -82

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