Please answer a to c. You are deciding between two mutually exclusive investment

Question

Please answer a to c.

You are deciding between two mutually exclusive investment opportunities. Both require the same initial investment of $10.1 million. Investment A will generate $1.95 million per year (starting at the end of the first year) in perpetuity. Investment B will generate $1.58 million at the end of the first year, and its revenues will grow at 2.1% per year for every year after that. Which investment has the higher IRR? Which investment has the higher NPV when the cost of capital is 5.3%? In this case, when does picking the higher IRR give the correct answer as to which investment is the best opportunity? Which investment has the higher IRR? The IRR of investment A is (Round to two decimal places.)

Explanation / Answer

a) Calculation of IRR:- Investment A:- Initial Investment 10.1 Mill $ Yearly Cash flows 1.95 Mill $ IRR = Perpetual Cash Flow/Initial Investment Therefore IRR 19.31 % (1.95/10.1*100) Investment B:- Initial Investment 10.1 Mill $ Yearly Cash flows 1.58 Mill $ IRR = ( Perpetual Cash Flow/Initial Investment)+Growth Rate Therefore IRR 17.74 % (1.58/10.1*100)+2.1 Investment A is higher IRR i.e., 19.31% . b) Calculation of NPV:- Investment A:- Initial Investment 10.1 Mill $ Yearly Cash flows 1.95 Mill $ Cost of Capital 5.30% Cumulative Value of Discounted Cash flows 36.79 (1.95/5.3%) NPV 26.69 (36.79-10.1) Investment B:- Initial Investment 10.1 Mill $ Yearly Cash flows 1.58 Mill $ Cost of Capital 5.30% Growth Rate 2.10% Cumulative Value of Discounted Cash flows 49.38 (1.95/(5.3-2.1)%) NPV 39.28 (49.38-10.1) **Investment B is higher NPV.39.28>26.69 c) When IRR has taken as decision parameter INVESTMENT Ais best option as it gives higher IRR.

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---

---

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