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	-1,250		730		360		270		315
Project B	-1,250		330		295		420		765

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

The IRR is the rate at which the NPV is zero,

The NPV can be calculated as :

($1250) + $730/ (1 + IRR)61 + $360/(1+ IRR)^2 + $270/(1+ IRR)^3 + $315/(1+ IRR)^4

= 15.6990%

= 15.7% ( rounded off to two decimal places)

Similarly, the IRR for project B is :

= 14.0971%

= 14.1 % ( rounded off to two decimal places)

If the projects were independent, we would have chosen both these projects as the IRR > 0.

Both projects A and B.

If the projects are mutually exclusive, we would have chosen the project which has the highest IRR.

So, we choose project A, as it has the higher IRR.

yes, there can be conflict between NPV and IRR when choosing mutually exclusive projects.

The reason for the conflict between NPV and IRR is that both these methods use a different reinvestment rate assumption.

The reinvestment rate assumption of the NPV is superior , so when conflict arises between NPV and IRR, the NPV should be chosen. The NPV assumes that the cash flows are reinvested at the discount rate and IRR assumes that the cash flows are reinvested at the IRR.