Question

Two projects being considered by a firm are mutually exclusive and have the following projected cash flows:

Year	Project A	Project B
0	($100,000)	($100,000)
1	39,500	0
2	39,500	0
3	39,500	133,000

Based only on the information given, which of the two projects would be preferred, and why?

1. Project A, because it has an even cash inflow stream.
2. Project B, because it has a higher IRR.
3. Indifferent, because the projects have equal IRRs.
4. Include both in the capital budget, since the sum of the cash inflows exceeds the initial investment in both cases.
5. Choose neither, since their NPVs are negative.

Answer 1

Project A

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$100,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of project is 8.9922% 9%.

Project B

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$100,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of project is 9.972% 9.97%

I would prefer project B since it has the highest internal rate of return.

Hence, the answer is option b.