Question

Bell Manufacturing is attempting to choose the better of two mutually exclusive projects for expanding the​ firm's warehouse capacity. The relevant cash flows for the projects are shown in the following​ table:

	Project X		Project Y
Initial investment ​(CF 0CF0​)	​$500,000		​$310,000
Year ​(t​)	Cash inflows ​(CF Subscript tCFt​)
1	​$130,000		​$140,000
2	​$130,000		​$140,000
3	​$130,000		​$85,000
4	​$180,000		​$90,000
5	​$270,000		​$30,000

The​ firm's cost of capital is 16​%.

a.  Calculate the IRR for each of the projects. Assess the acceptability of each project on the basis of the IRRs.

b.  Which project is​ preferred?

Answer 1

With the given values, we can determine the value of internal rate of return and net present value using excel as:

Formula used:

Hence, the value of IRR for project X is 17.49% and for project Y it is 21.51%. Similarly, NPV for project X and project Y are $19928.55 and $33177.95 respectively.

Part a:
According to IRR decision rule, a project with IRR greater than the cost of capital should be accepted.
As the IRR of project Y (that is 21.51%) is greater than the cost of capital of 16%, it should be accepted.

Part b:
Using the cost of capital, we determined the net present value for project X = $19928.55 and net present value for project Y = $33177.95.
We see that, IRR and NPV of project Y are greater than that of project X.
So, project Y is preferred.