Question

1. We have two mutually exclusive investments with the following cash flows: (13 marks total)

Year	Investment A	Investment B
0	-$100	-$100
1	50	20
2	40	40
3	40	50
4	30	60

1. Using a financial calculator, calculate the IRR for each of the investments. (1 mark)

b. Based on the IRR rule and a required return of 15%, which investment should we choose?   

c. Calculate the NPV profile for each investment, using the discount rates of 0%, 5%, 10%, 15%, 20%, and 25%. Perform this task in an Excel spreadsheet. Cautionary note: If you use the =NPV() function in Excel to calculate the NPVs, it will provide incorrect answers. The NPV() function actually calculates the present value of all cash inflows. The NPV should be calculated as =NPV(all cash inflows) – initial cash outflow.                                                            

d. Plot the NPV profile for both projects using the X-Y scatter function in Excel.                                                                                                      

e. If the required return on this project is 16%, would both NPV and IRR give us the same conclusion? Explain your answer.                                               (2.5 marks)

f.   If the required return on this project is 9%, would both NPV and IRR give us the same conclusion? Explain your answer.                                               (2.5 marks)

h. Calculate the crossover rate at which we are indifferent between the two investments.                                                                     

Answer 1

a]

First, we enter the cash flows for Investment A using CF button in the calculator

CF --> 0 --> Enter --> Down Arrow --> -100

CF --> 1 --> Enter --> Down Arrow --> 50

CF --> 2 --> Enter --> Down Arrow --> 40

CF --> 3 --> Enter --> Down Arrow --> 40

CF --> 4 --> Enter --> Down Arrow --> 30

Now, Press IRR --> CPT

IRR is calculated to be 24.00%

First, we enter the cash flows for Investment B using CF button in the calculator

CF --> 0 --> Enter --> Down Arrow --> -100

CF --> 1 --> Enter --> Down Arrow --> 20

CF --> 2 --> Enter --> Down Arrow --> 40

CF --> 3 --> Enter --> Down Arrow --> 50

CF --> 4 --> Enter --> Down Arrow --> 60

Now, Press IRR --> CPT

IRR is calculated to be 21.03%

b]

Both investments can be chosen as the IRR of both projects is higher than the required return.

c]

d]