Question

Karla is looking at two investment opportunities which have the following expected cash flows. If her minimum required return is 22%, which proposal would be the best based on what the instructor indicated was the more appropriate evaluation method? Investment A Investment B Year 0 $( 1,400,000) $( 1,400,000) Year 1 $ 454,000 $ 456,000 Year 2 $ 887,000 $ 891,000 Year 3 $ 760,000 $ 750,000 Year 4 $ 155,000 $ 145,000 a. Neither proposal would add value. b. Choose Proposal A because it has the highest IRR. c. Choose Proposal A because it has the highest NPV. d. Choose Proposal B because it has the highest IRR. e. Choose Proposal B because it has the highest NPV.

Answer 1

Answer:

c. Choose Proposal A because it has the highest NPV

Calculation:

Year	Cash Flow		PV factor @ 22%	Present Value of Cash Flow
	Investment A	Investment B		Investment A	Investment B
0	$             -14,00,000	$             -14,00,000	1	$     -14,00,000	$          -14,00,000
1	$                 4,54,000	$                 4,56,000	0.820	$         3,72,280	$              3,73,920
2	$                 8,87,000	$                 8,91,000	0.672	$         5,96,064	$              5,98,752
3	$                 7,60,000	$                 7,50,000	0.551	$         4,18,760	$              4,13,250
4	$                 1,55,000	$                 1,45,000	0.451	$            69,905	$                  65,395
	NPV			$            57,009	$                  51,317
	**Present Value of Cash Flow = Cash flow*PV factor

NPV is a better method for evaluating mutually exclusive projects than the IRR method.

----

Hope you Understood.
If you have any doubt please leave a comment.

Thank you.