Question

Bruin, Inc., has identified the following two mutually exclusive projects:

Year	Cash Flow (A)	Cash Flow (B)
0	-37,500	-37,500
1	17,300	5,700
2	16,200	12,900
3	13,800	16,300
4	7,600	27,500

1. What is the IRR for each of these projects? Using the IRR decision rule, which project should the company accept? Is this decision necessarily correct?
2. If the required return is 11 percent, what is the NPV for each of these projects? Which project will the company choose if it applies the NPV decision rule?

Answer 1

a.Cash flow A

Internal rate of return can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$37,500. The initial cash flow is indicated by a negative sign since it is a cash outflow.  
• Cash flow for each of the fifteen years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of the project is 19.71%.

Cash flow B

Internal rate of return can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$37,500. The initial cash flow is indicated by a negative sign since it is a cash outflow.  
• Cash flow for each of the fifteen years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of the project is 18.76%.

Using the IRR decision rule, Project A should be accepted since it has the highest internal rate of return. This decision need not necessarily be correct since internal rate of return suffers from the limitation that all cash flows are reinvested at the internal rate of return.

b.Cash flow A

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$37,500. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the required return of 11%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 11% required return is $6,330.67.

Cash flow B

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$37,500. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the required return of 11%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 11% required return is $8,138.59.

Using the NPV decision rule, Project B should be accepted since it has the highest internal rate of return.