Question

You are considering the following mutually exclusive projects. Both projects will be depreciated using straight line depreciation to a zero book value over the life of the project. Neither project has any salvage value.

Year	Project A	Year	Project B
0	$ - 75,000	0	$-70,000
1	19,000	1	10,000
2	48,000	2	16,000
3	12,000	3	72,000
Required Rate of Return	10%		13%
Required Payback Period	2 years		2 years
Required Accounting Return	8%		11%

1. Based on the net present value method of analysis, which project should you accept? Provide Proof.

2. Based on the on the internal rate of return analysis, which project should you accept? Provide Proof.

Answer 1

Answer 1
Calculation of net present value of both project using required rate of return as discount rate
Project A					Project B
Year	Discount factor @ 10%	Cash flow	Present value		Year	Discount factor @ 13%	Cash flow	Present value
0	1.00000	-$75,000.00	-$75,000.00		0	1.00000	-$70,000.00	-$70,000.00
1	0.90909	$19,000.00	$17,272.73		1	0.88496	$10,000.00	$8,849.56
2	0.82645	$48,000.00	$39,669.42		2	0.78315	$16,000.00	$12,530.35
3	0.75131	$12,000.00	$9,015.78		3	0.69305	$72,000.00	$49,899.61
NPV of Project A			-$9,042.07		NPV of Project B			$1,279.52
You should accept Project B as it has positive NPV.
Answer 2
Calculation of Internal rate of return of both projects
At IRR , the NPV of project is equal to zero.
Project A			Project B
Year	Cash flow		Year	Cash flow
0	-$75,000.00		0	-$70,000.00
1	$19,000.00		1	$10,000.00
2	$48,000.00		2	$16,000.00
3	$12,000.00		3	$72,000.00
IRR of Project A =	2.76%		IRR of Project B =	13.80%
The IRR of Project B is greater than Project A as well as it's required rate of return , hence you should select Project B.