Question

You are analyzing two mutually exclusive projects with the cash flows shown below. The cash flows are in millions. Both projects are equally risky. Your costs of capital are 12%.

Year	Project 1	Project 2
0	-$140	-$90
1	$50	$40
2	$45	$35
3	$40	$30
4	$35	$25
5	$30	$20
6	$25	$15
7	$20	$10
8	$15	$5
9	$10	$0
10	$5	-$5

1. Compute the NPVs of the two projects.

b. Compute the IRRs of the two projects.

c. Compute the simple payback periods of the two projects.

d. Compute the discount rate where you are indifferent between the projects (i.e., incremental IRR).

e. Which project should you execute? Briefly explain why.

Answer 1

B53 38 39 A-B 10 - X r fix =IRR(B41:351) A B C D E Cash flows PVIF@12% Year Project 1 | Project 2 Difference TALB o $ (140) $ (90) $ (50) 1.000 $ 1 $ 50 $ 40 $ 0.893 $ 2 $ 45 $ 35 $ 10 0.797 $ 3 $ 40 $ 30 $ 0.712 $ 4 $ 35 $ 25 $ 0.636 $ 5 $ 30$ 20 $ 0.567 $ 25$ 15 $ 0.507 $ 7 $ 20 $ 10 $ 10 0.452 $ 8 $ 15 $ 5 10 0.404 $ 9 $ 10 $ - $ 0.361 $ 10 $ 5 $ (5) $ 0.322 $ F G H I Present value Simple cumulative cash flows Project 1 | Project 2 Project 1 Project 2 AxC BxC (140.00) $ (90.00) $ (140) $ (90) 44.64 $ 35.71 $ (90) $ (50) 35.87 $ 27.90 $ (45) $ 28.47 $ 21.35 $ (5) $ 22.24 $ 15.89 $ 30 $ 40 17.02 $ 11.35 $ 60 $ 12.67 $ 7.60 $ 85 $ 75 9.05 $ 4.52 $ 105 $ 85 6.06 $ 2.02 $ 120 $ 90 3.61 $ 130 $ 90 1.61 $ (1.61) $ 135 $ 85 (15)/ 15 60 - IRR | 21.45% 26.57% $ 41.24 $ 34.74 15.10% NPV (Indifference IRR) Payback period 3.14 Years 2.50 Years =3+5/35 =2+15/30 59 Accept project 1

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