Question

Based on the NPV Profile Shown Below, what is the approximate internal rate of return (IRR)?

You work for a company whose primary long term financial goal is to undertake projects that maximize company value. You have been asked to provide a recommendation with respect to ranking three mutually exclusive projects. The first project has a NPV of $200K and an IRR of 10%; the second has a NPV of $180K and an IRR of $12%; the third has a NPV of 220K and an IRR of 9%. How would you rank the projects? Explain.

Using appropriate financial analysis tools (e.g., NPV, IRR, and payback analyses), your company has already identified several independent projects that will add value to the company. Unfortunately, the company has an insufficient capital budget to undertake all of the projects and management has declined additional debt or equity financing efforts to increase the capital budget. What recommendation would you make for selecting the appropriate projects?

Answer 1

1. IRR as per graph is 5.5 %

IRR is the interest rate at which the NPV of the investment is equal to zero.

2. Project Ranking - High ranking should be given to project with High NPV and High IRR

Rank	Ranking as per NPV	Ranking as per IRR
1	3 (NPV= 220K)	2 (IRR of $12%)
2	1 (NPV = $200K)	1 (IRR of 10%)
3	2 (NPV = $180K)	3 (IRR of 9%)

When NPV and IRR are not aligned then project with higher NPV should be chosen. Hence Project 3 should be chosen