In: Finance
You are choosing between two projects. The cash flows for the projects are given in the following table ($ million): Project Year 0 Year 1 Year 2 Year 3 Year 4 A negative $ 49 $ 23 $ 19 $ 20 $ 13 B negative $ 102 $ 22 $ 39 $ 50 $ 58 a. What are the IRRs of the two projects? b. If your discount rate is 5.3 %, what are the NPVs of the two projects? c. Why do IRR and NPV rank the two projects differently?
a.Project 1
Internal rate of return is calculated using a financial calculator by inputting the below:
The IRR of project is 21.40%.
Project 2
Internal rate of return is calculated using a financial calculator by inputting the below:
The IRR of project is 20.14%.
b.Project 1
Net present value is solved using a financial calculator. The steps to solve on the financial calculator:
Net Present value of cash flows at 5.3% the discount rate is $17.68.
Project 2
Net present value is solved using a financial calculator. The steps to solve on the financial calculator:
Net Present value of cash flows at 5.3% the discount rate is $44.06.
c.The reason why NPV and IRR rank projects differently is because of the criteria used by both the methods. For the net present value (NPV) criteria, the project with positive NPV is acceptable and the higher NPV is ranked higher. While, for the internal rate of return (IRR), a project is acceptable if the IRR is greater than the cost of capital and the project with the higher IRR is ranked higher.
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