2. A company is evaluating between two mutually exclusive projects. The estimate
ID: 2706587 • Letter: 2
Question
2. A company is evaluating between two mutually exclusive projects. The estimated cash flows are indicated below projects. The discount rate related to Project A 12% and the discount rate related to Project B is 16%.
a. Assuming the company is trying to maximize NPV which project should it undertake?
b. Assume the company is trying to maximize the IRR, which project should it undertake?
Year Project A Project B
0 ($100,000) ($5,000)
1 $0 $1,500
2 $0 $1,500
3 $0 $1,500
4 $0 $1,500
5 $0 $1,500
6 $250,000 $3,000
Discount rate: 12% 16%
a) NPV: ________ _______
b) IRR: ________ _______
Explanation / Answer
NPV OF PROJECT A = 250000*PVIF(12%,6) - 100000
= 250000*0.51 - 100000
=126658- 100000
=26658
NPV OF PROJECT B
=1500*PVIFA(16%,5)+3000*PVIF(16%,6) - 5000
=1500*3.274+3000*0.4104 - 5000
=1136
PROJECT A IS BETTER IN TERMS OF NPV.
IRR OF PRAJECT A
100000 = 250000/(1 +IRR)^6
IRR = 16.5%
IRR OF PROJECT B
5000 = 1500/(1+IRR)+1500/(1+IRR)^2+1500/(1+IRR)^3+1500/(1+IRR)^4+1500/(1+IRR)^5+3000/(1+IRR)^6
IRR > 23%
SO PROJECT B IS BETTER IN TERMSOF IRR
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