Question

A company is considering two investment options:

• Option 1: An investment of $45,000 today, and another investment of $15,000 in year 3, with returns of $18,000 in year 2, $7000 in year 3, and $50,000 in year 5.
• Option 2: An investment of $55,000 today, and another investment of $5000 in year 4, with returns of $15,000 in year 1, $16,000 in year 3, and $60,000 in year 5.

Calculate the internal rate of return for each option. Which investment option should the company select?  (Show ALL CF entries in the tables below. Justify your answer.)

Answer 1

IRR for option 1 is 6.91% and for option 2 is 12.36%

Company should select option 2 which has higher IRR

Justification - The general rule followed for IRR: The higher the better. In other words, all other things being equal, the project with the highest IRR should be selected.

Working- option 1, year 3 cashflow =-$15000+$7000 = -$8000

Year	Option 1	Option 2
0	$       -45,000	$       -55,000
1	$                  -	$         15,000
2	$         18,000	$                  -
3	$         -8,000	$         16,000
4	$                  -	$         -5,000
5	$         50,000	$         60,000
IRR using excel IRR formula	6.91%	12.36%

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