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	​$140,000		​$150,000
2	​$130,000		​$120,000
3	​$140,000		​$75,000
4	​$180,000		​$90,000
5	​$260,000		​$40,000

. The​ firm's cost of capital is15​%.

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

a. IRR is the internal rate of return at which present value of cash flows are equal to initial investment.

initial investment = year 1 cash flow/(1+IRR) + year 2 cash flow/(1+IRR)2 .... + year 5 cash flow/(1+IRR)5

IRR of Project X is 18.29% and Project Y 20.22%. based on IRR, both Project X and Y are acceptable because both have IRRs higher than firm's cost of capital of 15%. both Projects will make profits.

Years	Project X	Project Y
0	-$500,000	-$310,000
1	$140,000	$150,000
2	$130,000	$120,000
3	$140,000	$75,000
4	$180,000	$90,000
5	$260,000	$40,000
IRR	18.29%	20.22%

Calculations

b. Since both projects are mutually exclusive, so we can accept only one project. Project Y will be accepted because it has IRR of 20.22% higher than IRR of Project X's 18.29% and firm's cost of capital of 15%.