Question

                        Year 0             Year 1            Year 2             Year 3             Year 4

Project A         (4,000,000)     1,600,000       1,800,000        2,000,000        2,100,000

Project B         (4,200,000)     500,000          1,700,000        1,900,000        2,000,000

The cost of capital for Project A is assumed to be 14%.

For Project B, which is the riskier project of the two, a risk-adjusted cost of capital of 15% is applied.

(a) Assess the projects using the investment appraisal technique of Net Present Value.

(b) Assess them using the investment appraisal technique of Internal Rate of Return.

Answer 1

a.Project A

Net present value is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$4,000,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 14%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value of cash flows is $1,381,861.94.

Project B

Net present value is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$4,200,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 15%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value of cash flows is -$86,985.82.  

Only Project A can be accepted since it the only project with a positive net present value.

b. Project A

Internal rate of return is calculated using a financial calculator by inputting the below:

Press the CF button.

• CF0= -$4,000,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of project is 29.17%.

Project B

Internal rate of return is calculated using a financial calculator by inputting the below:

Press the CF button.

• CF0= -$4,200,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of project is 14.13%.

Both projects can be accepted since their internal rate of return is higher than the cost of capital.

In case of any query, kindly comment on the solution.