Question

A company is analyzing two mutually exclusive projects, S and L, with the following cash flows: 0 1 2 3 4 Project S -$1,000 $876.35 $250 $15 $10 Project L -$1,000 $5 $240 $420 $837.90 The company's WACC is 8.0%. What is the IRR of the better project? (Hint: The better project may or may not be the one with the higher IRR.) Round your answer to two decimal places. %

Answer 1

Year	Cashflows(S)	Discounting factor for 8%	Present value@8%	Discounting factor for 11.89%	Present [email protected]%	Cashflows(L)	Present value@8%	Discounting factor for 12.91%	Present [email protected]%
0	-1000	1	-1,000.00	1.00	-1,000.00	-1,000.00	-1,000.00	1.00	-1,000.00
1	876.35	0.93	811.44	0.89	783.22	5.00	4.63	0.89	4.43
2	250	0.86	214.33	0.80	199.69	240.00	205.76	0.78	188.25
3	15	0.79	11.91	0.71	10.71	420.00	333.41	0.69	291.78
4	10	0.74	7.35	0.64	6.38	837.90	615.88	0.62	515.54
	NPV		45.03		0.00		159.68		0.00
IRR	11.89%					12.91%

NPV is the present value of cash inflows less present value of cash outflows

Explaination:-
Internal rate of return is the rate where NPV of the project is zero. To calculate IRR, we should set NPV is equal to zero and solve for discount rate which is the IRR.
Using trial and error method we guessed the discounting rate for S to be 11.89% and L to be 12.91% .

Note for capital budgeting decisions NPV is considered as superior method for decision making. So select project L being its npv is higher.

IRR of preferred project i.e L is 12.91%