Question

Table with Cash Flows for 5 projects.

	Project A	Project B	Project C	Project D	Project E
Initial Investment	-$100,000	-$25,000	-$40,000	-$10,000	-$150,000
Year 1	$50,000	$15,000	$20,000	$7,000	$100,000
Year 2	$40,000	$10,000	$15,000	$4,000	$25,000
Year 3	$20,000	$5,000	$5,000	$2,000	$10,000
Year 4	$10,000	$1,000	$5,000	$1,000	$10,000
Year 5		$1,000			$10,000
Year 6		$1,000			$10,000

1. Calculate the IRR for each of the projects presented. Rank the projects based on their IRR.
2. Graph the projects on an Investment Opportunity Schedule (interest rate on the vertical axis and initial investment on the horizontal). Suppose the firm has a capital rationing amount of $170,000 and a required rate of return of 10%.
3. Which projects should the firm implement based on your analysis using the IRR approach above? Write an email to your CFO explaining your rationale proving the choices based on the considerations of shareholder value and the maximum investment budget.

Answer 1

ANS - PART(A) IRR has been calculated by using financial calculator . IRR is the point at which Present value of inflows = Present value of outflows. We can calculate by hit and trial method if no other option is available.

PART (C)

TO CFO

We should undertake Project D first because the cash outflow is low as compared to other projects and required rate pf return is very high. After that if we have surplus money we can undertake Project B because it also outlays lower investment and provide higher rate of return. Both project gives higher rate of return to shareholders and comes within budget constraint

NOTE - IRR can also be calculated by using equation

PV OF CASH OUTFLOW = PRESENT VALUE OF ALL CASH INFLOWS

= CF_{0 -} [CF₁ / (1+r)^T] + [CF₂ / (1+r)^T] + [CF₃ / (1+r)^T].........................................[CF_N / (1+r)^N]