Question

Tom is working on his universe conquest plan and is trying to decide between two mutually exclusive crusades led by his daughters Nebula and Gamora. The returns from each crusade is listed below:

Year-end Cash-Flow
Project	0	1	2	3	IRR
Nebula	-30	15	20	10	24.81%
Gamora	-80	39	52	15	17.59%

Tom can undertake only one crusade? If you were his consultant, which crusade would you advise and why? Assume that cost of capital for Tom is 8%

Answer 1

NEBULA				GAMORA
YEAR	CASH FLOW	COST OF CAPITAL @8%	PRESENT VALUE OF CASH FLOW	YEAR	CASH FLOW	COST OF CAPITAL @8%	PRESENT VALUE OF CASH FLOW
0	-30	1	-30	0	-80	1	-80
1	15	0.926	13.89	1	39	0.926	36.11
2	20	0.857	17.14	2	52	0.857	44.56
3	10	0.794	7.94	3	15	0.794	11.91
		NPV	8.97			NPV	12.588
		IRR	24.81%			IRR	17.59%

Net present value(NPV) is the difference between the present value of cash inflows and cash outflows.

· The projects having positive NPV or NPV>0 then the project has to be accepted.

· And in case of negative NPV or NPV<0, then we have to reject the project.

IRR also referred as “yield to redemption or yield per annum. The internal rate of return for an investment project is the effective rate of interest that equates the present value of inflows and outflows. Higher IRR represents a more profitable project.

However, IRR need not be positive. Zero return implies investor receives no return on investment. If the project has only cash inflows then the IRR is infinity.

Now when IRR> cost of capital, then NPV will be positive

When IRR< cost of capital, NPV will be negative.

But NPV is much better as compared to IRR.

In the present case crusade with higher NPV is to be accepted i.e crusade lead by his daughter Gamora