Question

The Box Company was confronted with the two mutually exclusive investment projects, A and B, which have the following after-tax cash flows:

Cash Flows, per Year ($)

Project                                0                1                         2                   3                          4

A                                   (12,000)        5,000               5,000              5,000                5,000

B                                   (12,000)            Nil                     Nil                    Nil            25,000

Based on these cash flows:

(a) Calculate each project’s NPV and IRR. (Assume that the firm’s cost of capital after taxes is 10 percent.)

(b) Suggest to the management as to which project to be chosen based on the IRR criterion.

(c) Evaluate the rankings given by the NPV and IRR methods

Answer 1

Answer : Below is the Table showing Net Present value of Project A and B

Project A :

Year	Cash Inflow	Present Value Factor @10%	Present value of cash inflow
1	5000	0.909090909	4545.454545
2	5000	0.826446281	4132.231405
3	5000	0.751314801	3756.574005
4	5000	0.683013455	3415.067277
		Total Present value of cash inflow	15849.32723
		Less : Cash outflow	12000
		Net Present Value	3849.33

Project B

Year	Cash Inflow	Present Value Factor @10%	Present value of cash inflow
1	0	0.909090909	0
2	0	0.826446281	0
3	0	0.751314801	0
4	25000	0.683013455	17075.33638
		Total Present value of cash inflow	17075.33638
		Less : Cash outflow	12000
		Net Present Value	5075.34

Calculation of IRR of Project A and B :

Below is the image showing calculation of IRR

(b.) Based on IRR critrion Management should choose Project A as it has higher IRR.

(c.) Ranking

Project	NPV	IRR
A	2	1
B	1	2

As per NPV Project B will be choosen as it has higher Net Present Value but as per IRR project A will be choosen as it has higher IRR. But in Case of Conflict generally we used to select the project with the higher Net Present value.