Question

Mr Tommy Tan is considering two potential investment projects that have similar capital requirements:

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

For Project A, the company cost of capital is assumed to be 14%. For Project B, assessed as the riskier project of the two, a risk-adjusted cost of capital of 15% is considered appropriate.

Calculate the IRR of the two (2) projects and assess the projects using the investment appraisal technique of Internal Rate of Return.

Answer 1

Project A
IRR is the rate at which NPV =0
IRR	0.291677736
Year	0	1	2	3	4
Cash flow stream	-4000000	1600000	1800000	2000000	2100000
Discounting factor	1	1.291678	1.668431	2.155076	2.7836633
Discounted cash flows project	-4000000	1238699	1078858	928041.7	754401.6
NPV = Sum of discounted cash flows
NPV Project A =	6.54137E-05
Where
Discounting factor =	(1 + IRR)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	29.17%
Project B
IRR is the rate at which NPV =0
IRR	0.141305557
Year	0	1	2	3	4
Cash flow stream	-4200000	500000	1700000	1900000	2000000
Discounting factor	1	1.141306	1.302578	1.48664	1.6967104
Discounted cash flows project	-4200000	438094.8	1305104	1278050	1178751.5
NPV = Sum of discounted cash flows
NPV Project B =	3.26429E-07
Where
Discounting factor =	(1 + IRR)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	14.13%

Choose project A as it has higher IRR