. A firm is considering Projects S and L, whose cash flows are shown below. Thes

Question

. A firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise the firm on the best procedure. If the wrong decision criterion is used, how much potential value would the firm lose?
WACC: 6.00%
Year 0 1 2 3 4
CFS -$1,025 $380 $380 $380 $380
CFL -$2,150 $765 $765 $765 $765
a. $188.68
b. $198.61
c. $209.07
d. $219.52
e. $230.49

Explanation / Answer

We should use NPV to calculate which project to start. This is because IRR is not comparible if both projects have different initial starting cost.

Using excel to find the NPV:

Project L should be selected. However, if project S was selected, the cost of this mistake is:

$500.81 - $291.74 = $209.07

Answer is C

Year Project S Project L 0 -1025 -2150 1 380 765 2 380 765 3 380 765 4 380 765 NPV $291.74 $500.81

Related Questions

Navigate

• Browse (All)
• Browse #
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.