Question

The IRR calculation assumes that cash flows are reinvested at the . If the IRR is than the project's risk-adjusted cost of capital, then the project should be accepted; however, if the IRR is less than the project's risk-adjusted cost of capital, then the project should be . Because of the IRR reinvestment rate assumption, when projects are evaluated the IRR approach can lead to conflicting results from the NPV method. Two basic conditions can lead to conflicts between NPV and IRR: differences (earlier cash flows in one project vs. later cash flows in the other project) and project size (the cost of one project is larger than the other). When mutually exclusive projects are considered, then the method should be used to evaluate projects. Quantitative Problem: Bellinger Industries is considering two projects for inclusion in its capital budget, and you have been asked to do the analysis. Both projects' after-tax cash flows are shown on the time line below. Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. Both projects have 4-year lives, and they have risk characteristics similar to the firm's average project. Bellinger's WACC is 10%. 0 1 2 3 4 Project A -1,200 630 330 290 350 Project B -1,200 230 265 440 800 What is Project A’s IRR? Do not round intermediate calculations. Round your answer to two decimal places. % What is Project B's IRR? Do not round intermediate calculations. Round your answer to two decimal places. % If the projects were independent, which project(s) would be accepted according to the IRR method? If the projects were mutually exclusive, which project(s) would be accepted according to the IRR method? Could there be a conflict with project acceptance between the NPV and IRR approaches when projects are mutually exclusive? The reason is Reinvestment at the is the superior assumption, so when mutually exclusive projects are evaluated the approach should be used for the capital budgeting decision.

Answer 1

1-	reinvested at a rate equal to IRR
2-	IRR is greater
3-	Project should be rejected
4-	Misleading results
5-	the cost of one project is larger than the other
6-	NPV method in case of mutually exclusive projects
7-	project A			project B
	Year	cash flow		Year	cash flow
	0	-1200		0	-1200
	1	630		1	230
	2	330		2	265
	3	290		3	440
	4	350		4	800
	IRR =Using IRR function in MS excel irr(-1200,630,330,290,350)	14.44%		IRR =Using IRR function in MS excel irr(-1200,230,265,440,800)	13.22%
	Both project should be accepted as IRR is greater than cost of capital but Project A would be selected as its IRR greater than Project B
	if the project are mutually exclusive then project A would be accepted
	Yes there would be conflict
	NPV method should be used