Question

Consider the following two​ projects:

Project    Year 0 Cashflow   Year 1 Cashflow    Year 2 Cashflow    Year 3 Cashflow   Year 4 Cashflow Discount rate

A    -100 40 50 60 N/A .15

B -147   50 70 90 5 .15

An incremental IRR of Project B over Project A is _________%.

(Please round to two decimal places, write the number only without "%". i.e. if the answer is "5%", write "5.00")

Answer 1

Incremental IRR is the analysis of return to investor when there are two investment opportunities that involves different cost structures and best investment opportunity needs to be find out between them. The analysis is done on the difference between the cash flows. so we subtract the cash flows associated with the less expensive alternative from the cash flows associated with the more expensive alternative to arrive at the cash flows applicable to the difference between the two alternatives, and then conduct an internal rate of return analysis on this difference.

First, we will find the NPV and IRR of both projects and subtract the cash flows of Project 1 from Project 2. Then from the incremental cash flows, we will calculate Incremental IRR.

The incremental IRR is 14%