Question

These are the cash flows for two projects. Calculate the NPV and IRR for both. Then select the best project according to the NPV measure. Use a WACC of 10% for both projects. The investments are 7 for project 1, and 8 for project 2. Cash flows for project 1 year 1 2 3 4 cash 4 6 2 4 Cash flows for project 2 year 1 2 3 4 cash 3 2 7 4

Calculate the NPV for project 1. Remember to use 10% as the WACC.

Calculate the IRR for project 1. Remember the WACC is 10%. Give the answer in percent.

Calculate the NPV for project 2, use a 10% WACC.

Calculate the IRR for project 2, write the result in percent.

According to the NPV criterion, which is the best project to invest in?

Answer 1

1)

project 1:

NPV = Present value of cash inflows - present value of cash outflows

NPV = -7 + 4 / (1 + 0.1)¹ + 6 / (1 + 0.1)² + 2 / (1 + 0.1)³ + 4 / (1 + 0.1)⁴

NPV = $5.83

2)

IRR is the rate of return that makes NPV equal to 0.

NPV = -7 + 4 / (1 + R)¹ + 6 / (1 + R)² + 2 / (1 + R)³ + 4 / (1 + R)⁴

Using trial and error method, i.e., after trying various values for R, let's try R as 46.83

NPV = -7 + 4 / (1 + 0.4683)¹ + 6 / (1 + 0.4683)² + 2 / (1 + 0.4683)³ + 4 / (1 + 0.4683)⁴

NPV = 0

Therefore, IRR is 46.83%

3)

project 2:

NPV = Present value of cash inflows - present value of cash outflows

NPV = -8 + 3 / (1 + 0.1)¹ + 2 / (1 + 0.1)² + 7 / (1 + 0.1)³ + 4 / (1 + 0.1)⁴

NPV = $4.37

4)

IRR is the rate of return that makes NPV equal to 0.

NPV = -8 + 3 / (1 + R)¹ + 2 / (1 + R)² + 7 / (1 + R)³ + 4 / (1 + R)⁴

Using trial and error method, i.e., after trying various values for R, let's try R as 30.51

NPV = -8 + 3 / (1 + 0.3051)¹ + 2 / (1 + 0.3051)² + 7 / (1 + 0.3051)³ + 4 / (1 + 0.3051)⁴

NPV = 0

Therefore, IRR is 30.51%

5)

Project 1 as it has the highest NPV