Question

You are choosing between two projects. The cash flows for the projects are given in the following table​ ($ million):

Project

Year 0

Year 1

Year 2

Year 3

Year 4

A                                             -$52                                   $24                               $20                             $21                                   $17

B                                             -$100                                 $18                               $38                             $51                                   $60

a. What are the IRRs of the two​ projects? The IRR for project A is_______​%. ​(Round to one decimal​ place.)

b. If your discount rate is 4.9%​, what are the NPVs of the two​ projects?______.

c. Why do IRR and NPV rank the two projects​ differently?______.

Answer 1

The question is solved here using a financial calculator.

a.Project A

This is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$52
• Cash flow for each year is entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the IRR button to get the IRR of the project.

The IRR is 22.38%.

Project B

The question is solved using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$100
• Cash flow for each year is entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the IRR button to get the IRR of the project.

The IRR is 19.93%.

b.Project A

The following should be entered in a financial calculator:

• Press the CF button.
• CF0= -$52
• Cash flow for the first and second year is entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter 4.9%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value is $21.3.

Project B

The following should be entered in a financial calculator:

• Press the CF button.
• CF0= -$100
• Cash flow for the first and second year is entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter 4.9%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value is $45.4.

c.According to the NPV rule, the project should be selected since it has a higher net present value.

According to the internal rate of return, project A should be selected since it has a higher internal rate of return.

The IRR and NPV ranks projects differently because NPV assumes that project cash flows are reinvested at the discount rate while, IRR assumes that project cash flows are reinvested at the internal rate of return.

It is essentially also because NPV measures the value creation and IRR measures return on investment.