Question

Short Answer questions: Consider two mutually exclusive projects X and Y with identical initial outlays of $600,000 and useful lives of 5 years. Project X is expected to produce an after-tax cash flow of $180,000 each year. Project Y is expected to generate a single after-tax net cash flow of $1,015,000 in year 5. The discount rate is 14 percent.

Calculate Net Present Value for each project

Calculate IRR for each project

What should you decide based on the two projects

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Answer 1

Project X
Discount rate	14.000%
Year	0	1	2	3	4	5
Cash flow stream	-600000	180000	180000	180000	180000	180000
Discounting factor	1.000	1.140	1.300	1.482	1.689	1.925
Discounted cash flows project	-600000.000	157894.737	138504.155	121494.873	106574.450	93486.360
NPV = Sum of discounted cash flows
NPV Project X =	17954.57
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Project Y
Discount rate	14.000%
Year	0	1	2	3	4	5
Cash flow stream	-600000	0	0	0	0	1015000
Discounting factor	1.000	1.140	1.300	1.482	1.689	1.925
Discounted cash flows project	-600000.000	0.000	0.000	0.000	0.000	527159.194
NPV = Sum of discounted cash flows
NPV Project Y =	-72840.81
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Project X
IRR is the rate at which NPV =0
IRR	15.24%
Year	0	1	2	3	4	5
Cash flow stream	-600000.000	180000.000	180000.000	180000.000	180000.000	180000.000
Discounting factor	1.000	1.152	1.328	1.530	1.764	2.032
Discounted cash flows project	-600000.000	156198.155	135543.686	117620.410	102067.172	88570.577
NPV = Sum of discounted cash flows
NPV Project X =	0.000
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	15.24%

Project Y
IRR is the rate at which NPV =0
IRR	11.09%
Year	0	1	2	3	4	5
Cash flow stream	-600000.000	0.000	0.000	0.000	0.000	1015000.000
Discounting factor	1.000	1.111	1.234	1.371	1.523	1.692
Discounted cash flows project	-600000.000	0.000	0.000	0.000	0.000	600000.000
NPV = Sum of discounted cash flows
NPV Project Y =	0.000
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	11.09%

Accept project X as it has positive NPV and IRR greater than discount rate