Question

The estimated cashflows for two mutually exclusive projects are shown below.

(A) Using a cost of capital of 14%, which project should be taken based on the NPV amounts?

(B) Calculate the IRR for both projects.  Based on the IRR amounts, which project should be taken?

(C) Why are your answer to parts A and B not the same?

(D) Using a cost of capital of 17%, which project should be taken based on the NPV amounts?

(E) Create an NPV profile for the net cashflows form the two projects with discount rates from 0% to 20% in increments of 1%.  You do not need to create the graph.

Notice in your NPV profile that the two lines cross at about 16%.  This is called the crossover point.

(F) Use the IRR function to calculate the exact cross-over point.

(G) Next use the value you just calculated with the IRR function as the new discount rate for both projects, and calculate the NPV of both projects.  

(H) What do you find from your answers to part G?

	A	B
0	($350,000)	($1,200,000)
1	$140,000	$410,000
2	$130,000	$350,000
3	$110,000	$330,000
4	$90,000	$270,000
5	$70,000	$210,000
6	$50,000	$150,000
7	$50,000	$150,000
8	$50,000	$150,000

Answer 1

a]

NPV is calculated using NPV function in Excel

Project B should be accepted as it has a higher NPV

b]

IRR is calculated using IRR function in Excel

Project A should be chosen as it has a higher IRR

c]

The answers are not the same since Project B has a much higher initial investment.

d]

Project A should be accepted as it has a higher NPV