Question

1. Bumble’s Bees, Inc., has identified the following two mutually exclusive projects:

Year	Cash Flow (A)	Cash Flow (B)
0	-17,000	-17,000
1	8,000	2,000
2	7,000	5,000
3	5,000	9,000
4	3,000	9,500

1. What is the IRR for each of these projects? If you apply the IRR decision rule, which project should the company accept? Is this decision necessarily correct?
2. If the required return is 11%, what is the NPV for each of these projects? Which project will you choose if you apply the NPV decision rule?

c.Over what range of discount rates would you choose Project A? Project B? At what discount rate would you be indifferent between these two projects? Explain

(Please type calculations, do not write them because sometimes it is harder to read)

Answer 1

Based on the given data, pls find below steps, workings and answers:

1. What is the IRR for each of these projects? If you apply the IRR decision rule, which project should the company accept? Is this decision necessarily correct?

IRR of Project A is 15.86% and that of Project B is 14.69%; Based on the IRR criteria, Project A is chosen as the same is with higher as compared to the other; IRR, individually, should not be considered as a criteria for capital budgeting selection; This is one requirement to assess the rate of return generated by the investment thru the future cash flows; However, other techniques like NPV, payback period, etc need to be considered.

2. If the required return is 11%, what is the NPV for each of these projects? Which project will you choose if you apply the NPV decision rule?

NPV of Project A is $1520.71 and that of Project B is $1698.58; Based on the NPV criteria, Project B is chosen as the same is with higher as compared to the other. This is due to the time value of the money.

c.Over what range of discount rates would you choose Project A? Project B? At what discount rate would you be indifferent between these two projects? Explain

For Project A, the discount rate lower than its IRR 15.86 % shall be considered as feasbile and similarly, for Project B, the discount rate lower than its IRR 14.69% shall be feasbile; However, both these projects have a cross-over rate of IRR at 12.18% at whcih the economic value of both these projects are indifferent.

Computation of IRR: This can be computed using formula in Excel = IRR("range of cashflows", discounting factor%);

Computation of Net Present Value (NPV) based on the Discounted Cash flows; The Discounting factor is computed based on the formula: For year 0, the discounting factor is 1; For Year 1, it is computed as = Year 0 factor /(1+discounting factor%) ; Year 2 = Year 1 factor/(1+discounting factor %) and so on;

Next, the cashflows need to be multiplied with the respective years' discounting factor, to arrive at the discounting cash flows;

The total of all the discounted cash flows is equal to its respective Project NPV of the Cash Flows;