Question

Project S requires an initial outlay at t = 0 of $16,000, and its expected cash flows would be $6,000 per year for 5 years. Mutually exclusive Project L requires an initial outlay at t = 0 of $40,500, and its expected cash flows would be $12,100 per year for 5 years. If both projects have a WACC of 16%, which project would you recommend?

Select the correct answer.

a. Project L, since the NPVL > NPVS.

b. Both Projects S and L, since both projects have IRR's > 0.

c. Neither Project S nor L, since each project's NPV < 0.

d. Project S, since the NPVS > NPVL.

e. Both Projects S and L, since both projects have NPV's > 0.

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	$873.06	$250	$10	$10
Project L	-$1,000	$0	$250	$420	$822.83

The company's WACC is 9.0%. 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

1. use NPV function in EXCEL to find the NPV of two projects.

=NPV(rate,Year1 to Year5 cashflows)-Year0 cashflow

NPV,Project S=NPV(16%,Year1 to Year5 cashflows)-16000=$3645.76

NPV,Project L=NPV(16%,Year1 to Year5 cashflows)-40500=-$881.05

WACC	16.00%
	Project S	Project L
Year0	-16000	-40500
Year1	6000	12100
Year2	6000	12100
Year3	6000	12100
Year4	6000	12100
Year5	6000	12100
NPV	3645.76	-881.05

Option d is correct

NPV of Project S>NPV of project L

2. Use IRR function in EXCEL to find the IRR

=IRR(Year0 to Year4 cashflows)

Project S,IRR=IRR(Year0 to Year4 cashflows)=11.3%

Project L,IRR=IRR(Year0 to Year4 cashflows)=12.7%

	Project S	Project L
Year0	-1000	-1000
Year1	873.06	0
Year2	250	250
Year3	10	420
Year4	10	822.83
IRR	11.3%	12.7%

Project L has better IRR because of higher than Project S.