Question

IRR and NPV A company is analyzing two mutually exclusive projects, S and L, with the following cash flows: 0 1 2 3 4 Project S -$1,000 $872.52 $260 $15 $10 Project L -$1,000 $0 $250 $380 $811.10 The company's WACC is 10.0%. What is the IRR of the better project? (Hint: The better project may or may not be the one with the higher IRR.) Round your answer to two decimal places.

Answer 1

Solution: Statement showing NPV from Project S and Project L :
			Project S		Project L
Particulars	Time	PVf 10%	Amount (in $)	PV	Amount (in $)	PV
Cash Out Flows	0	1	1,000	1,000	1000	1,000
PV of Cash Out Flows (A)				1,000		1,000
Cash Inflows	1	0.9091	872.50	793.19	0	0
Cash Inflows	2	0.8264	260.00	214.86	250	206.60
Cash Inflows	3	0.7513	15.00	11.27	380	285.49
Cash Inflows	4.00	0.6830	10.00	6.83	811.10	553.98
PV of Cash Inflows (B)				1,026.15		1,046.08
NPV (B)-(A)				26.15		46.08
Advise:Since project are mutually exclusive , on the basis of NPV project L has the higher NPV. Project L should be accepted
Calculation of IRR of Accepted Project i.e. Project L
NPV at 12% = 0/(1.12)^1+250/1.12)^2+380/(1.12)^3+811.10/(1.12)^4-1000*1
NPV= 0+250*0.7972+380*0.7118+811.10*0.6355 - 1000
NPV= 0+199.30+270.48+515.45-1000
NPV= -14.77
NPV at 11% = 0/(1.11)^1+250/1.11)^2+380/(1.11)^3+811.10/(1.11)^4-1000*1
NPV= 0+250*0.8116+380*0.7312+811.10*0.6587-1000
NPV=0+202.90+277.86+534.27-1000
NPV= 15.03
IRR= Lower Rate + (Lower Rate NPV/ Lower Rate NPV- Higher Rate NPV)*Difference in rates
IRR= 11% + (15.03/15.03-(-14.77))*1%
IRR= 11%+ (15.03/29.80)*1%
IRR= 11%+0.504%
IRR= 11.504%
IRR of Project L at which NPV is 0 = 11.504%