22 Week 5_-HW_(Ch. 7 in book) Saved Problem 7-13 NPV versus IRR Consider the fol

Question

22 Week 5_-HW_(Ch. 7 in book) Saved Problem 7-13 NPV versus IRR Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporation. Both projects requi an annual return of 18 percent. ipped Deepwater Submarine New Fishing Ride ear 0 $1,050,000-$2,050,000 1470,000 1,100,000 900,000 950,000 eBook 2 590,000 520,000 a-1. Compute the IRR for both projects. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g, 32.16.) Deepwater Fishing Submarine Ride % 0-2 Based on the IRR, which project should you choose? O Submarine Ride O Deepwater Fishing b-1. Calculate the incremental IRR for the cash flows kDo not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g. 32.16) Incremental IRR

Explanation / Answer

a-1) IRR is that discount rate for which the NPV is 0. The same has to be found out by trial and error using different discount rates as below: Deepwater: Year Cashflow PVIF at 24% PV at 24% PVIF at 23% PV at 23% 0 -1050000 1.00000 -1050000 1.00000 -1050000 1 470000 0.80645 379032 0.81301 382114 2 590000 0.65036 383715 0.67191 396425 3 520000 0.52449 272733 0.55530 288754 -14519 17293 IRR lies between 23% and 24%. The value can be found by simple interpolation as below: IRR = 23+17293/(17293+14519) = 23.54 Submarine ride: Year Cashflow PVIF at 22% PV at 22% PVIF at 21% PV at 21% 0 -2050000 1.00000 -2050000 1.00000 -2050000 1 1100000 0.81967 901639 0.82645 909091 2 900000 0.67186 604676 0.68301 614712 3 950000 0.55071 523172 0.56447 536250 -20513 10053 IRR lies between 21% and 22%. The value can be found by simple interpolation as below: IRR = 21+10053/(10053+20513) = 21.33 a-2) Deepwater fishing (as it has higher IRR) Both projects are acceptable, their IRRs being greater than MRR. b-1) Incremental IRR (Submarine ride-Deepwater fishing) Year Cashflow PVIF at 20% PV at 20% PVIF at 191% PV at 19% 0 -1000000 1.00000 -1000000 1.00000 -1000000 1 630000 0.83333 525000 0.84034 529412 2 310000 0.69444 215278 0.70616 218911 3 430000 0.57870 248843 0.59342 255169 -10880 3492 IRR = 19+3492/(3492+10880) = 19.24 b-2) As the incremental IRR>18, the Project with higher initial investment, Submarine ride is chosen. c-1) Deepwater: Year Cashflow PVIF at 18% PV at 18% 0 -1050000 1.00000 -1050000 1 470000 0.84746 398305 2 590000 0.71818 423729 3 520000 0.60863 316488 NPV 88522 Submarine ride: Year Cashflow PVIF at 18% PV at 18% 0 -2050000 1.00000 -2050000 1 1100000 0.84746 932203 2 900000 0.71818 646366 3 950000 0.60863 578199 NPV 106769 c-2) Submarine ride c-3) No

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