Question

Here are the cash flows for two mutually exclusive projects:

Project                 C0                           C1                           C2                           C3

A                             -20,000                 +8,000                   +8,000                   +8,000

B                             -20,000                 0                              0                              +25,000

              

At what interest rate would you prefer project A to B? (Hint: try drawing a NPV profile.)

                a)            If the discount rate is below 3%.

                b)            If the discount rate is above 3%.

                c)            If the discount rate is above 4%.

                d)            A is never preferred to B at any discount rate.

Which project has the highest IRR?

a.Project A

b. Project B

c. They have equal IRRs.

Answer 1

1: c

2: a

Year	A	B
0	-20000	-20000
1	8000	0
2	8000	0
3	8000	25000
NPV at 2%	3071.07	3558.06	Select B
NPV at 3.5%	$2,413.10	$2,548.57	Select B
NPV at 4.5%	$1,991.71	$1,907.42	Select A
IRR	9.70%	7.72%	A has higher IRR

Workings