Question

Douglas controls, Inc. is considering tow mutually exclusive, equallly risky, and not repeatable projects, S and L. Thier cash flows are shown below. The CEO believes the IRR is the best selection criterion, while the CFO advocates the NPV. If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone, i.e., what's the chosen NPV versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some condidtions the choice of IRR vs. NPV will not affect the value gained or lost. Douglas has a weighted average cost of capital (WACC) of 8.50%.

Year 0 1 2 3 4

CF S        -$1,100 $550 $600 $100 $100

CF L        -$2,700 $550 $725 $800 $1,400 A. $62.96    B. $0.00 C. $119.66    D. $27.50

Answer 1

Year	CF of S	CF of L
0	$ -1,100.00	$ -2,700.00
1	$      550.00	$       550.00
2	$      600.00	$       725.00
3	$      100.00	$       800.00
4	$      100.00	$    1,400.00
WACC	8.50%	8.50%
NPVat 8.5%	$         67.03	$          59.30
IRR	12.24%	9.35%
NPV()	NPV(WACC, Cashflow 1-4) + Cashflow at 0
IRR()	IRR(All cashflow 0 to 4)

In both the cases with respect to IRR and NPV, Project S is preferred over Project L. hecne, for choosing IRR criteria won't make any value loss. Option B (0)

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