Arrow Electronics is considering Projects S and L, which are mutually exclusive,

Question

Arrow Electronics is considering Projects S and L, which are mutually exclusive, equally risky, and not repeatable. Project S has an initial cost of $1 million and cash inflows of $370,000 for 4 years, while Project L has an initial cost of $2 million and cash inflows of $720,000 for 4 years. The CEO wants to use the IRR criterion, while the CFO favors the NPV method, using a WACC of 7.27%. You were hired to advise the firm on the best procedure. If the wrong decision criterion is used, how much potential value would the frm lose? That is, what is the difference between the NPVs for these two projects? Your answer should be between 112000 and 202000, rounded to even dollars (although decimal places are okay), with no special characters.

Explanation / Answer

NPV for project S = -$1,000,000 + $370,000/(1+7.27%) + $370,000/(1+7.27%)2 + $370,000/(1+7.27%)3 + $370,000/(1+7.27%)4 = $245667

NPV for project L = -$2,000,000 + $720,000/(1+7.27%) + $720,000/(1+7.27%)2 + $720,000/(1+7.27%)3 + $720,000/(1+7.27%)4 = $424000

Difference in NPVs = $424000- $245667 = $178333

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