Question

12. NPV versus IRR (LO1, 5) Parkallen Inc. has identified the following two mutually exclusive projects: m Cash Flow (A) Cash Flow (B) Year -$29,000 14,400 -$29000 0 1 4,300 2 12,300 q.800 4.200 15,200 4 5,100 16,800 Click here for a description of Table: Questions and Problems 12. a. What is the IRR for each of these projects? Using the IRR decision rule, which project should the company accept? Is this decision necessarily correct? b. If the required return is 11 percent, what is the NPV for each of these projects? Which project will the company choose if it applies the NPV decision rule? c. 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.

Answer 1

Using excel formula we get

		A	B
1	Year	Cash Flow(A)	Cash Flow(B)
2	0	-29000	-29000
3	1	14400	4300
4	2	12300	9800
5	3	9200	15200
6	4	5100	16800
	IRR	18.56%	17.42%
	Excel Formula	IRR(A2:A6)	IRR(B2:B6)
	NPV	4042.42	5008.56
	Excel Formula	NPV(11%,A2:A6)+A2	NPV(11%,B2:B6)+B3

a. Based on IRR Project A should be accepted. This decision might not necessarily be correct .


b. Based on NPV Project B should be accepted because NPV of Project B is higher.

c.

		A	B	C
1	Year	Cash Flow(A)	Cash Flow(B)	Difference in cash flow
2	0	-29000	-29000	0
3	1	14400	4300	10100
4	2	12300	9800	2500
5	3	9200	15200	-6000
6	4	5100	16800	-11700
			IRR	14.83%
			excel formula	IRR(C2:C3)

Discount rate at which cash flows will be indifferent =14.83%

Project A would be selected by when discount rate is less than 14.83%. Project B should be selected when discount rate is greater than 14.83%