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

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. Based on the IRR criterion and the NPV criterion, which project should be selected?

Required return: 6.00%

Year

0

1

2

3

4

Cash flows of Project S

-$1,055

$400

$400

$400

$400

Cash flows of Project L

-$2,050

$700

$700

$700

$700

IRR criterion - Project S; NPV criterion - Project L

IRR criterion - Project S; NPV criterion - Project S

IRR criterion - Project L; NPV criterion - Project L

IRR criterion - Project L; NPV criterion - Project S

IRR criterion - Project S or Project L; NPV criterion - Project S or Project L

Year

0

1

2

3

4

Cash flows of Project S

-$1,055

$400

$400

$400

$400

Cash flows of Project L

-$2,050

$700

$700

$700

$700

Explanation / Answer

Answer:

Project L is selected because its NPV is greater than Project S

Year Cash flow of project S P.V.F (6%) PV ($) 0 -1055 1 -1055 1 400 0.9434 377.36 2 400 0.89 356 3 400 0.8396 335.84 4 400 0.7921 316.84 NPV 331.04

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