Question

Which assertion about statement 1 and statement 2 is true?  

Project A would cost 19,998 dollars today and have the following other expected cash flows: 3,983 dollars in 1 year, 7,670 dollars in 3 years, and 13,620 dollars in 4 years. The cost of capital for project A is 6.11 percent. Project B would cost 16,941 dollars today and have the following other expected cash flows: 2,942 dollars in 1 year, 6,526 dollars in 3 years, and 13,004 dollars in 4 years. The cost of capital for project B is 8.6 percent.

Statement 1: Project A would be accepted based on the project’s net present value (NPV) and the NPV rule

Statement 2: Project B would be accepted based on the project’s internal rate of return (IRR) and the IRR rule

		Statement 1 is true and statement 2 is true
		Statement 1 is false and statement 2 is false
		Statement 1 is false and statement 2 is true
		Statement 1 is true and statement 2 is false

Answer 1

Answer: Statement 1 is true and statement 2 is True.

Project selection on the basis of NPV
Project A NPV	918.83	(Working Given Below)
Project B NPV	211.42	(Working Given Below)
Project A NPV is higher, Therefore Project A will be accepted based on NPV
Project selection on the basis of IRR
Project A	7.64%		(Working Given Below)
Project B	9.02%		(Working Given Below)
Project B IRR is higher, Therefore Project B will be accepted based on IRR
Computation of NPV - Project A
Year	Cash Flow	P.V. Factor	Present Value
	[Inflow/(outflow]	[@6.11%]	[Cash Flow*P.V. Facotr]
0	-19998	1	-19998.00
1	3983	0.9424	3753.58
2	0	0.8882	0.00
3	7670	0.837	6419.79
4	13620	0.7888	10743.46
Net Present Value		918.83
Computation of NPV - Project B
Year	Cash Flow	P.V. Factor	Present Value
	[Inflow/(outflow]	[@8.6%]	[Cash Flow*P.V. Facotr]
0	-16941	1	-16941.00
1	2942	0.9208	2708.99
2	0	0.8479	0.00
3	6526	0.7807	5094.85
4	13004	0.7189	9348.58
Net Present Value		211.42
Internal Rate of Return
IRR is a rate whrere the NPV of the project is zero. Since both the projects' NPV is positive, Their IRR will be higher than the discounting rate. Further, the NPV of both the projects is very minimal, the IRR will be near to the discounting rate. We have to calculate it with trial & error method. The IRR of both the projects is as below:
Project A	7.64%
Project B	9.02%