Question

9)

A firm with a WACC of 10% is considering the following mutually exclusive projects:

0

1

2

3

4

5

Project 1	-$200	$70	$70	$70	$165	$165
Project 2	-$550	$300	$300	$130	$130	$130

Which project would you recommend?

Select the correct answer.

a. Neither Project 1 nor 2, since each project's NPV < 0.

b. Project 2, since the NPV2 > NPV1.

c. Both Projects 1 and 2, since both projects have IRR's > 0.

d. Project 1, since the NPV1 > NPV2.

e. Both Projects 1 and 2, since both projects have NPV's > 0.

Answer 1

Project 1
Discount rate	10.000%
Year	0	1	2	3	4	5
Cash flow stream	-200	70	70	70	165	165
Discounting factor	1.000	1.100	1.210	1.331	1.464	1.611
Discounted cash flows project	-200.000	63.636	57.851	52.592	112.697	102.452
NPV = Sum of discounted cash flows
NPV Project 1 =	189.23
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

IRR is the rate at which NPV =0
IRR	36.20%
Year	0	1	2	3	4	5
Cash flow stream	-200.000	70.000	70.000	70.000	165.000	165.000
Discounting factor	1.000	1.362	1.855	2.526	3.441	4.686
Discounted cash flows project	-200.000	51.396	37.737	27.707	47.952	35.208
NPV = Sum of discounted cash flows
NPV Project 1 =	0.000
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	36.20%

Project 2
Discount rate	10.000%
Year	0	1	2	3	4	5
Cash flow stream	-550	300	300	130	130	130
Discounting factor	1.000	1.100	1.210	1.331	1.464	1.611
Discounted cash flows project	-550.000	272.727	247.934	97.671	88.792	80.720
NPV = Sum of discounted cash flows
NPV Project 2 =	237.84
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Project 2
IRR is the rate at which NPV =0
IRR	29.77%
Year	0	1	2	3	4	5
Cash flow stream	-550.000	300.000	300.000	130.000	130.000	130.000
Discounting factor	1.000	1.298	1.684	2.185	2.836	3.680
Discounted cash flows project	-550.000	231.184	178.153	59.491	45.844	35.328
NPV = Sum of discounted cash flows
NPV Project 2 =	0.000
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	29.77%