Suppose your firm is considering two mutually exclusive, required projects with
ID: 2779191 • Letter: S
Question
Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 10 percent. Project A s Cash flow from year 0 to year 3: -1000, 400, 400, 700. Project B s Cash flow from year 0 to year 3: -500, 200, 300, 300. Which statement is correct?
Accept A, reject B, because B has lower IRR
Reject A, accept B, because B has higher IRR
Accept A, reject B, because A has higher NPV
Reject A, accept B, because B has higher NPV
Accept A, reject B, because B has lower IRR
Reject A, accept B, because B has higher IRR
Accept A, reject B, because A has higher NPV
Reject A, accept B, because B has higher NPV
Explanation / Answer
NPV at 10% Project A Project B Cash Flow Discount Rate Cash Flow Cash Flow Discount Rate Cash Flow -1000 1 -1000 -500 1 -500 400 0.909091 363.6364 200 0.909091 181.8182 400 0.826446 330.5785 300 0.826446 247.9339 700 0.751315 525.9204 300 0.751315 225.3944 Net Present Value 220.1352 Net Present Value 155.1465 NPV at 25% NPV at 30% Cash Flow Discount Rate Cash Flow Cash Flow Discount Rate Cash Flow -1000 1 -1000 -500 1 -500 400 0.8 320 200 0.769231 153.8462 400 0.64 256 300 0.591716 177.5148 700 0.512 358.4 300 0.455166 136.5498 Net Present Value -65.6 Net Present Value -32.0892 IRR = Lower Rate+ NPV at Lower Rate/ NPV at lower rate+ NPV at higher Rate ( HR-LR) 20 0.828651 IRR = 10+220.12/220.13+65.6 ( 25-10) 187.22 16.57302 IRR = 10+11.55 IRR = 21.55 IRR = Lower Rate+ NPV at Lower Rate/ NPV at lower rate+ NPV at higher Rate ( HR-LR) IRR = 10+155.14/155.14+32.08 ( 30-10) IRR = 10+16.57 IRR = 26.57 The correct answer is A. Accept A, reject B, because B has lower IRR
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