Question

Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporation (BRC). Both projects require an annual return of 15%. Year Deepwater Fishing New Submarine Ride 0 -600,000 -1,800,000 1 270,000 1,000,000 2 350,000 700,000 3 300,000 900,000 as a financial analyst for BRC, you are asked the following questions: a. Based on the discounted payback period rule, which project should be chosen? b. If your decision rule is to accept the project with the greater IRR, which project should you use? c. Since you are fully aware of the IRR rule’s scale problem, you calculate the modified IRR (MIRR) for the two projects. Based on your

computation, which project should you choose? d. To be prudent, you compute the NPV for both projects. Which project should you choose? Is it consistent with the MIRR rule?

Answer 1

Based on Discounted Payback Project 1( Deep water fishing) is chosen as it has lower payback period.

As Per IRR criteria, Project new submarine is chosen due to higher IRR

Based on MIRR rule , Project Deepwater fishing is chosen again due to higher MIRR.

Based on NPV rule, Project New submarine is chosen and this is not consistent with the MIRR rule.

Formulae