A firm has three independent projects under consideration each with a required r

Question

A firm has three independent projects under consideration each with a required rate of return of 10%/ The total projects budget is only $2,000. Project X has an initial investment of $2,000 and a single cash flow in year one of $2,360. Project Y has an initial investment of $1,000 and a single cash flow in year one of $1,200. Project Z has an initial investment of $1,000 and a single cash flow in year one of $1,170. Calculate the IRR and NPV for each of these projects. If we assume that we cannot "repeat" these projects (i.e., we cannot do project Z twice) which project or combination of projects should the firm undertake? Why?

Explanation / Answer

Calculate the IRR and NPV for each of these projects.

Project x.

NPV = -2000 + 2360 / (1 + .10) = $145.46

IRR = (2360 / 2000) - 1 = 18%

Project y

NPV = -1000 + $1200 / (1 + .10) = $90.91

IRR = (1200 / 1000) - 1 = 20%

Project Z

NPV = -1000 + $1170 / (1 + .10) = $63.64

IRR = (1170 / 1000) - 1 = 8.5%

If we assume that we cannot "repeat" these projects (i.e., we cannot do project Z twice) which project or combination of projects should the firm undertake? Why?

Projects Y and Z should be done. This will allow for both projects to be done and results in a higher NPV and overall return than compared to doing project x by itself. It also falls within the $2000 budget

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