You are deciding between two mutually exclusive investment opportunities. Both r

Question

You are deciding between two mutually exclusive investment opportunities. Both require the same initial investment of

$ 10

million. Investment A will generate

$ 2.3

million per year? (starting at the end of the first? year) in perpetuity. Investment B will generate

$ 1.9

million at the end of the first? year, and its revenues will grow at

2.1 %

per year for every year after that. Use the incremental IRR rule to correctly choose between investments A and B when the cost of capital is

7.5 %

The incremental IRR is

nothing?%.

Explanation / Answer

IRR is the rate at which NPV is Zero = 0

Investment A: NPV = (Inflows/ IRR) - Outflows

0= ($ 2.3 million / IRR) - $ 10 million

10=2.3/IRR

IRR= 0.23 or 23%

Investment B : NPV = (Inflows/ IRR - g) - Outflows

0 = ($1.9 million / IRR- 0.021) - $10 million

10= (1.9 / IRR- 0.021)

10IRR - 0.21 = 1.9

10 IRR = 2.11

IRR = 0.211 or 21.10%

Conclusion: Investment A has higher IRR of 23% So we will pick Investment A based on IRR

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.