Question

You have two potential investment projects, Project A and Project B. You can take one, but not both. The annual cash flows for the two projects are:

Year	0	1	2	3
Project A Cash Flow	-$50,000	$45,000	$5,000	$5,000
Project B Cash Flow	-$50,000	$5,000	$5,000	$50,000

a. Compute the IRR for each project. b) Compute the NPV for each project if the appropriate discount rate is 5%.   Which project would you take, and why? c)  Compute the NPV for each project if the appropriate discount rate is 10%. Which project would you take, and why? d) Summarize the principles demonstrated by this problem.

Answer 1

Using excel to calculate IRR and NPV at 5% and NPV at 10%

		A	B
	Year	Project A	Project B
1	0	-50000	-50000
2	1	45000	5000
3	2	5000	5000
4	3	5000	50000
	NPV at 5%	$1,711.48	$2,488.93
	Using excel formula	NPV(0.05,A2:A5)+A1	NPV(0.05,B2:B5)+B1
	IRR	7.87%	6.89%
	Using excel formula	IRR(A1:A7)	IRR(B1:B7)
	NPV at 10%	-$1,202.10	-$3,756.57
	Using excel formula	NPV(0.1,A2:A5)+A1	NPV(0.1,B2:B5)+B1

at 5% Project B should be Chosen Because NPV of B is higher than NPV of A
at 10% Project A should be Chosen Because NPV of A is higher than NPV of B


d) The NPV is preferred over IRR because it is more accurate.
NPV can be different at different discount rates and hence decision changes with discount rate. The cross over rate is the Rate at which NPV is same. Above that rate some projects are accepted and some are rejected.

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