Question

intro

You've estimated the following cash flows (in $) for two mutually exclusive projects: Year Project A Project B 0 -5,200 -7,800 1 1,325 1,325 2 2,148 2,148 3 3,655 7,335 The required return for both projects is 8%. Attempt 1/5 for 10 pts. Part 1 What is the IRR for project A?

The IRR is that discount rate that sets the NPV to zero: N P V = 0 = C F 0 + C F 1 1 + IRR + C F 2 ( 1 + IRR ) 2 + C F 3 ( 1 + IRR ) 3 ⇔ 0 = − 5,200 + 1,325 1 + IRR + 2,148 ( 1 + IRR ) 2 + 3,655 ( 1 + IRR ) 3 Since this is a non-linear equation, it cannot be solved analytically. However, we can use trial and error, a financial calculator or Excel's IRR function to do it for us. We then find that the IRR is 14.8%, or 0.148. Correct ✓

Part 2 What is the IRR for project B?

N P V = 0 = C F 0 + C F 1 1 + IRR + C F 2 ( 1 + IRR ) 2 + C F 3 ( 1 + IRR ) 3 ⇔ 0 = − 7,800 + 1,325 1 + IRR + 2,148 ( 1 + IRR ) 2 + 7,335 ( 1 + IRR ) 3 The IRR is 13.8%, or 0.138. Correct ✓

Part 3 Which project seems better according to the IRR method?

Project B     Project A

Project A's IRR of 0.148 is greater than project B's IRR of 0.138. Project A is thus better. Since the IRR is also greater than the required return, the company will add value by pursuing project A. Correct ✓

Part 4

What is the NPV for project A?

Answer 1

Year	A	B
0	-5200	-7800
1	1325	1325
2	2148	2148
3	3655	7335
IRR	14.80%	13.80%
NPV	769.87	1091.18

Workings