Two mutually exclusive projects have cash flows as shown below. What is the IRR

Question

Two mutually exclusive projects have cash flows as shown below. What is the IRR of each project? Based on information given so far, can you give a recommendation, which project to accept? Please explain. When would you accept project 1 - at lower or higher discount rates? Explain When would you accept project 2 - at lower or higher discount rates? Explain At what discount rate would you be indifferent between the two projects? What is this point called on a diagram? What is the IRR of each project? Based on information given so far, can you give a recommendation, which project to accept? Please explain. When would you accept project 1 - at lower or higher discount rates? Explain When would you accept project 2 - at lower or higher discount rates? Explain At what discount rate would you be indifferent between the two projects? What is this point called on a diagram

Explanation / Answer

Answer-b

Project-2 Scores high on IRR as its IRR = 43.54% is well above the IRR of Project-1 which is 23.38%.

So as per the IRR criteria Project-2 is acceptable.

Answer-c

We can accept projects at discount rate lower than the IRR only. As in that case only we can have positive NPV.

Answer-d

We can accept projects at discount rate lower than the IRR only. As in that case only we can have positive NPV.

Answer-e

We have to find out the differential cash flows of Project-1 and 2 and then IRR of those cash flows to get that discount rate at which we would be indifferent between the projects.

So the indifference rate = 15.38%

This point on the graph is known as indifference point.

Year Project -1 Project -2 Difference between P-1 and P-2 0 -100 -40 -60 1 50 40 10 2 50 25 25 3 50 50 IRR = 15.38%

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