Garage Inc. has identified the following two mutually exclusive (i.e. it can onl
ID: 2782955 • Letter: G
Question
Garage Inc. has identified the following two mutually exclusive (i.e. it can only do one or the other but not both) projects with cash flows as outlined below.
Year
Cash Flow (A)
Cash Flow (B)
0
-$43,500
-$43,500
1
21,400
6,400
2
18,500
14,700
3
13,800
22,800
4
7,600
25,200
What is the IRR for each project? Using the IRR decision rule, which project should the company select? IS this necessarily correct?
If cost of capital (e.g. required return hurdle rate) is 11%, what is the NPV for each of these projects? Using the NPV rule, which project would the company select?
Over what range of discount rates would the company choose project A? Project B? At what discount rate would the company be indifferent between these two projects? Explain.
Year
Cash Flow (A)
Cash Flow (B)
0
-$43,500
-$43,500
1
21,400
6,400
2
18,500
14,700
3
13,800
22,800
4
7,600
25,200
Explanation / Answer
IRR and NPV can be calculated using the same function in excel or calculator
Using IRR method, we select A as IRR (A) > IRR (B)
Using NPV method, we select B as NPV (B) > NPV (A)
Indifference rate can be calculated by computing IRR for the difference in cash flows for both projects.
Indifference rate = 15.19%
If the discount rate is below 15.19%, then we select Project B.
If the discount rate is above 15.19%, then we select Project A.
Year Cash Flow (A) Cash Flow (B) 0 -$43,500 -$43,500 1 21,400 6,400 2 18,500 14,700 3 13,800 22,800 4 7,600 25,200 IRR 18.33% 17.37% NPV $5,891.09 $7,467.80Related Questions
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