Question

Jefferson International is trying to choose between the following two mutually exclusive design projects. The required return is 12 percent. If the company applies the internal rate of return (IRR) decision rule, which project should the firm accept? If the company applies the NPV decision rule, which project should it take? Given your first two answers, which project should the firm actually accept?

Year	Project A	Project B
0	-$75,000	-$38,000
1	$32,400	$17,800
2	$30,200	$14,200
3	$36,600	$19,800

Answer 1

a.Let irr be x%
At irr,present value of inflows=present value of outflows.

A:

75000=32400/1.0x+30200/1.0x^2+36600/1.0x^3

Hence x=irr=15.06%(Approx)

B:

38000=17800/1.0x+14200/1.0x^2+19800/1.0x^3

Hence x=irr=16.92%(Approx)

Hence as per irr rule Project B must be selected having higher IRR.

b.A:

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=32400/1.12+30200/1.12^2+36600/1.12^3

=79054.98

NPV=Present value of inflows-Present value of outflows  

=79054.98-75000

=$4054.98(Approx)

B:

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=17800/1.12+14200/1.12^2+19800/1.12^3

=41306.26

NPV=Present value of inflows-Present value of outflows  

=41306.26-38000

=$3306.26(Approx)

Hence as per NPV rule Project A must be selected having higher NPV

c.Since projects are mutually exclusive;project having higher NPV must be selected ie Project A