Question

Quantitative Problem: Bellinger Industries is considering two projects for inclusion in its capital budget, and you have been asked to do the analysis. Both projects' after-tax cash flows are shown on the time line below. Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. Both projects have 4-year lives, and they have risk characteristics similar to the firm's average project. Bellinger's WACC is 11%.

	0		1		2		3		4
Project A	-1,250		730		360		270		315
Project B	-1,250		330		295		420		765

What is Project A’s IRR? Do not round intermediate calculations. Round your answer to two decimal places.
______%

What is Project B's IRR? Do not round intermediate calculations. Round your answer to two decimal places.
______%

If the projects were independent, which project(s) would be accepted according to the IRR method?
Neither or Project A or Project B or Both projects A and B

If the projects were mutually exclusive, which project(s) would be accepted according to the IRR method?
Neither or Project A or Project B or Both projects A and B

Could there be a conflict with project acceptance between the NPV and IRR approaches when projects are mutually exclusive?
YES or NO

The reason is: The NPV and IRR approaches use the same reinvestment rate assumption so both approaches reach the same project acceptance when mutually projects are considered.the NPV and IRR approaches use different reinvestment rate assumptions so there can be a conflict in project acceptance when mutually exclusive projects are considered.

Reinvestment at the ________ is the superior assumption, so when mutually exclusive projects are evaluated the ________ approach should be used for the capital budgeting decision.

Answer 1

1.Project A

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

• Press the CF button.
• CF0= -$1,250. The initial cash flow is indicated by a negative sign since it is a cash outflow.  
• Cash flow for each of the fifteen years 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 the project is 15.70%.

Project B

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

• Press the CF button.
• CF0= -$1,250. The initial cash flow is indicated by a negative sign since it is a cash outflow.  
• Cash flow for each of the fifteen years 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 the project is 14.10%.

2.If the projects were independent, both projects should be accepted according to the IRR method since the internal rate of return of the projects is higher than the cost of capital.

3.If the projects were mutually exclusive, Project A should be accepted since it has the highest internal rate of return.

4.Yes, there could be a conflict with project acceptance when projects are mutually exclusive.

5.The reason is the NPV and IRR approaches use different reinvestment rate assumptions so there can be a conflict in project acceptance when mutually exclusive projects are considered.

6. Reinvestment at WACC is the superior assumption, so when mutually exclusive projects are evaluated the NPV approach should be used for the capital budgeting decision.