Question

You are evaluating the following mutually exclusive projects for your firm, whose cost of capital is 14%, and all dollar amounts are in millions.

1. Verify the NPV and IRR of each project.

2. What is your recommendation?

Project	Required Return	Life	IO	NCF1-n	NPV	IRR
Alpha	12%	10 years	$50	$20	$63	38.45%
Beta	8%	5	$50	$25	$49.82	41.04%

EAABeta = $12.48 million > EAAAlpha = $11.15 million so

Accept B and Reject A Is the answer- Please explain why

Answer 1

Answer 1)

Project	Rate	Life	IO	NCF	NPV		IRR
Alpha	12%	10	$50	$20	$63.00	PV(12%,10,-20)-50	38%
Beta	8%	5	$50	$25	$49.82	PV(8%,5,-25)-50	41.04%

Answer 2)

Here, recommendation should be based out on the Equivalent Annual Annuity Approach.

EAA = (r x NPV) / (1 - (1 + r)^-n )

for Project Alpha EAA = (0.12*63)/(1-(1.12^-10)) = $ 11.150

for Project Beta EAA = (0.08*48.82)/(1-(1.08^-5)) = $ 12.48

As EAA of Beta > EAA of Alpha ,

So, Accept B and Reject A