Projects S and L, whose cash flows are shown below, are mutually exclusive, equa

Question

Projects S and L, whose cash flows are shown below, are mutually exclusive, equally risky, and not repeatable. Hooper Inc. is considering which of these two projects to undertake. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under certain conditions choosing projects on the basis of the IRR will not cause any value to be lost because the project with the higher IRR will also have the higher NPV, so no value will be lost if the IRR method is used.

WACC: 10.25% Year 0 1 2 3 4 CFS -$2,050    $750    $760    $770    $780 CFL -$4,300 $1,500 $1,518 $1,536 $1,554

Explanation / Answer

The IRRs can be derived through trial and error method. Below is a summary of the same :

Therefore, the project with the higher IRR is Project S.

The value lost would be as calculated below :

$ [(4807.40 - 4300.45) - (2408.05 - 2050.36)] = $ 149.36

Option c. is correct

IRR Estimate PVS PVL 10.25% 2408.05 4807.40 18.05% 2050.36 - 15.572% - 4300.45

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