Question

Bellinger Industries is considering two projects for inclusion in its capital budget, and you have been asked to do the analysis. Both projects' after-tax cash flows are shown on the time line below. Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. Both projects have 4-year lives, and they have risk characteristics similar to the firm's average project. Bellinger's WACC is 11%.

	0		1		2		3		4
Project A	-1,050		600		360		300		290
Project B	-1,050		200		295		450		740

What is Project A’s IRR? Do not round intermediate calculations. Round your answer to two decimal places.

%

What is Project B's IRR? Do not round intermediate calculations. Round your answer to two decimal places.

%

If the projects were independent, which project(s) would be accepted according to the IRR method?

-Select-NeitherProject AProject BBoth projects A and BCorrect 1 of Item 3

If the projects were mutually exclusive, which project(s) would be accepted according to the IRR method?

-Select-Neither Project AProject BBoth projects A and BCorrect 2 of Item 3

Could there be a conflict with project acceptance between the NPV and IRR approaches when projects are mutually exclusive?

-Select-YesNoCorrect 3 of Item 3

The reason is -Select-the NPV and IRR approaches use the same reinvestment rate assumption and so both approaches reach the same project acceptance when mutually exclusive projects are considered.the NPV and IRR approaches use different reinvestment rate assumptions and so there can be a conflict in project acceptance when mutually exclusive projects are considered.Correct 4 of Item 3

Reinvestment at the -Select-IRRWACCCorrect 5 of Item 3 is the superior assumption, so when mutually exclusive projects are evaluated the -Select-NPVIRRCorrect 6 of Item 3 approach should be used for the capital budgeting decision.

Answer 1

IRR can be found using IRR function in EXCEL

=IRR(values)

Project A IRR=IRR(year0 to year4 cashflows)

IRR=20.8%

Project B IRR=IRR(year0 to year cshflows)

IRR=17.5%

3.If projects are independent, both projects can be selected because of higher IRR than WACC

4.If projects are mutually exclusive, accept the project which has high IRR. Project A

5. No,in both cases NPV and IRR, project A should be selected.

6.NPV does not assume any reinvestment rate, but IRR assumes the cashflows to be reinvested at IRR rate. Hence there could be chances that both give different results

7.Generally we should see the NPV because it tells that by how much shareholder's wealth has been increased. Projects can have multiple IRR's based on changes in the future cashflow estimates.

Hence, they should go with NPV for final decision making.