Question

s. Understanding the NPV profile Aa Aa If an independent project with conventional, or normal, cash flows is being analyzed, the net present value (NPV) and internal rate of return (IRR) methods agree. Projects W and X are mutually exclusive projects. Their cash flows and NPV profiles are shown as follows. NPV (Dollars) Year Project W Project x 800 0 - $1,500 -$1,000 $200 $350 600 Project X 2 $350 $500 $400 $600 400 4 $600 $750 Project W 200 If the weighted average cost of capital (WACC) for each project is 14 % , do the NPV and IRR methods agree or conflict? -200 0 2 46 8 10 12 14 16 18 20 O The methods conflict. O The methods agree. COST OF CAPITAL IPercent) A key to resolving this conflict is the assumed reinvestment rate. The NPV calculation implicitly assumes that , and the IRR calculation intermediate cash flows are reinvested at the assumes that the rate at which cash flows can be reinvested is the earch 8 @G i If an independent project with conventional, or nomal, Cash flow agree. and internal rate of return (IRR) methods cash flows and NPV profiles are shown as follows. Projects W and X are mutually exclusive projects. Their NPV IDollars) Year Project W Project X 800 -$1,000 -$1,500 1 $200 $350 600 Project X $500 2 $350 3 $400 009$ $750 400 $600 Project W 200 If the weighted average cost of capital (WACC) for each project is 14% , do the NPV and IRR methods agree or conflict? -200 The methods conflict. O The methods agree. 0 24 6 8 10 12 14 16 18 20 COST OF CAPITAL (Percent) A key to resolving this conflict is the assumed reinvestment rate. The NPV calculation implicitly assumes that ,and the IRR calculation intermediate cash flows are reinvested at the assumes that the rate at which cash flows can be reinvested is the As a result, when evaluating mutually exclusive projects, the is usually the better decision criterion. earch

Answer 1

We need to caculate the exact NPV and IRR for both the projects in order to know the comparison.

[We can find the same through graphs also]

Through Graph

For NPV [Find Points where Cost of capital = 14%

For IRR [Find point where NPV = 0]

Now calculating via excel

Discount Rate/WACC (r)	14%
PROJECT W
years	0	1	2	3	4
Cash-Outflows	1,000
Cash-Inflows		200	350	400	600
Net Cashflows (Inflow - Outflow)	-1,000	200	350	400	600
Discounted Cashflow = Net CF / (1+r)^years	-1,000	175	269	270	355
NPV = sum of all discounted CF	69.99
IRR = IRR (net CF)	16.852%
PROJECT X
years	0	1	2	3	4
Cash-Outflows	1,500
Cash-Inflows		350	500	600	750
Net Cashflows (Inflow - Outflow)	-1,500	350	500	600	750
Discounted Cashflow = Net CF / (1+r)^years	-1,500	307	385	405	444
NPV = sum of all discounted CF	40.79
IRR = IRR (net CF)	15.167%

Hence, we can see

NPV (Project W) > NPV (Project X), implies Project W is better than Project X

and IRR (Project W) > IRR (Project X).. both have IRR > WACC and hence both rae favourable, But Project W > Project X

Hence both methods AGREE.