Question

Your company is choosing between the following non-repeatable, equally risky, mutually exclusive projects with the cash flows shown below. Your cost of capital is 10 percent. How much value will your firm sacrifice if it selects the project with the higher IRR?

k = 10% Project S: 0 1 2 3 | | | | -1,000 500 500 500 k = 10% Project L: 0 1 2 3 4 5 | | | | | | -2,000 668.76 668.76 668.76 668.76 668.76

a. $243.43 b. $291.70 c. $332.50 d. $481.15

Answer 1

Solution :

The IRR of Project S = 23.38 %

The NPV of Project S = $ 243.43

The IRR of Project L = 20 %

The NPV of Project L = $ 535.13

In case the company selects project S, which has the higher IRR, it will sacrifice the excess of Project L's NPV over the NPV of Project S.

= NPV of project L - NPV of project S

= $ 535.13 - $ 243.43 = $ 291.70

Thus the solution is Option b. 291.70

Please find the attached screenshots of the excel sheet containing the detailed calculation for the solution.