Question

HH Companies has identified two mutually exclusive projects. Project A has cash flows of −$40,000, $21,200, $16,800, and $14,000 for Years 0 to 3, respectively. Project B has a cost of $38,000 and annual cash inflows of $25,500 for 2 years. At what rate would you be indifferent between these two projects? Select one: a. 6.34 percent b. −1.72 percent c. 9.41 percent d. −4.38 percent e. 8.28 percent

Answer 1

Calculation of incremental cash flow
Year	Cash Flow-A	Cash Flow-B	Differential cash flow
0	$          (40,000.00)	$ (38,000.00)	(2,000)
1	$           21,200.00	$ 25,500.00	(4,300)
2	$           16,800.00	$ 25,500.00	(8,700)
3	$           14,000.00	$               -	14,000
Calculation of cross over rate	-5%	-4%
Year	Cash flow-1	PV factor, 1/(1+r)^t	PV factor, 1/(1+r)^t	PV@-5%	PV@-4%
0	$                 (2,000)	1.0000	1.0000	$      (2,000.00)	$ (2,000.00)
1	$                 (4,300)	1.0526	1.0417	$      (4,526.32)	$ (4,479.17)
2	$                 (8,700)	1.1080	1.0851	$      (9,639.89)	$ (9,440.10)
3	$                14,000	1.1664	1.1303	$     16,328.91	$ 15,823.93
			NPV	$          162.71	$       (95.34)
		IRR	=Lower rate + Difference in rates*(NPV at lower rate)/(Lower rate NPV-Higher rate NPV)
		IRR	'=-5%+ (-4%--5%)*(162.71/(162.71+95.34)
		IRR	-4.38%