Question

The Roger Company has the choice between two different types of die. One type cost less, but it also has a shorter life expectancy. the expected cash flows after taxes for the two diferent dies are as follows:

Period    0             1              2             3                4

A             (10000)      8000        8000

B             (12000)      5000        5000         5000           5000

The hurdle rate for this project is 10 percent.

Answer 1

Assume that the project A can be repeated again at period 2 (cashinflow from period 3) so that both projects can be of equal period.

Net Cash Flows of Project A and Project B:

Period	0	1	2	3	4
A	-$10,000	$8,000	$8,000
			-$10,000	$8,000	$8,000
Net Cash Flow Project A	-$10,000	$8,000	-$2,000	$8,000	$8,000
Cash Flow Project B	-$12,000	$5,000	$5,000	$5,000	$5,000

Now calculate internal rate of return (IRR) and Net present value (NPV) of both projects –

Period (t)	Cash Flow A	PV/(1+10%)^t	Cash Flow B	PV/(1+10%)^t
0	-$10,000	-$10,000.00	-$12,000	-$12,000.00
1	$8,000	$7,272.73	$5,000	$4,545.45
2	-$2,000	-$1,652.89	$5,000	$4,132.23
3	$8,000	$6,010.52	$5,000	$3,756.57
4	$8,000	$5,464.11	$5,000	$3,415.07
IRR	37.98%		24.10%
NPV		$7,094.46		$3,849.33

As the internal rate of return (IRR) and Net present value (NPV) both are more for project A, therefore Roger Company should choose project A.