Question

In: Finance

You are choosing between two projects. The cash flows for the projects are given in the...

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?

Solutions

Expert Solution

a.Project 1

Internal rate of return is calculated using a financial calculator by inputting the below:

  • Press the CF button.
  • CF0= -$49. It is entered with a negative sign since it is a cash outflow.
  • Cash flow for each year should be entered.
  • Press Enter and down arrow after inputting each cash flow.
  • After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of project is 21.40%.

Project 2

Internal rate of return is calculated using a financial calculator by inputting the below:

  • Press the CF button.
  • CF0= -$102. It is entered with a negative sign since it is a cash outflow.
  • Cash flow for each year should be entered.
  • Press Enter and down arrow after inputting each cash flow.
  • After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

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:

  • Press the CF button.
  • CF0= -$49. It is entered with a negative sign since it is a cash outflow.
  • Cash flow for all the years should be entered.
  • Press Enter and down arrow after inputting each cash flow.
  • After entering the last cash flow, press the NPV button and enter the discount rate of 5.3%.
  • Press the down arrow and CPT buttons to get the net present value.

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:

  • Press the CF button.
  • CF0= -$102. It is entered with a negative sign since it is a cash outflow.
  • Cash flow for all the years should be entered.
  • Press Enter and down arrow after inputting each cash flow.
  • After entering the last cash flow, press the NPV button and enter the discount rate of 5.3%.
  • Press the down arrow and CPT buttons to get the net present value.

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.

In case of any query, kindly comment on the solution.


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