Question

1. Big Company is evaluating two projects, Project A and Project B. Both projects are of equal risk. Big Company has a WACC of 10%. The expected Free Cash Flows of the projects are as follows:

Period	Project A	Project B
0	(25,000)	(25,000)
1	5000	20000
2	10000	10000
3	15000	8000
4	20000	6000

1. Compute the Internal Rate of Return of Project “A”.

2. The Internal Rate of Return of Project “B” is 36.15%. If Projects “A” and “B” are independent, considering only at the IRR method, which project(s) should Big Company proceed with

3. The Internal Rate of Return of Project “B” is 36.15%. If Projects “A” and “B” are mutually exclusive, considering only at the IRR method, which project(s) should Big Company proceed with?

SHOW WORK PLEASE

Answer 1

1.

Let the IRR be x.

Now , Present Value of Cash Outflows=Present Value of Cash Inflows

25000 = 5000/(1.0x) +10000/ (1.0x)^2 +15000/(1.0x)^3+ 20000/(1.0x)^4      

Or x= 27.273%

Hence the IRR is 27.273%

2. When the two projects are independent, considering only at the IRR method, Project A and B would be chosen as both have a higher IRR than the Cost of capital and hence both would be beneficial.

3. When Projects “A” and “B” are mutually exclusive, considering only at the IRR method, the project with the higher IRR would be chosen. This is because in case of mutually exclusive projects, only of the projects would be chosen.

Hence the answer is Project B