Do all the problems. Include calculations and/or explanations in your answers wh
ID: 2643995 • Letter: D
Question
Do all the problems. Include calculations and/or explanations in your answers wherever appropriate. More credit will be given for correct reasoning than for correct arithmetic.
1. Alpha Co. is investigating two mutually exclusive projects A and B with common cost of capital k = 6%.
here A: -$5,000, $1,646, $1,646, $1,646, $1,646 NPV = $704 IRR = 12%
B: -$2,000, $701, $701, $701, $701. NPV = $429 IRR = 15%
(a) Calculate the NPV
Explanation / Answer
a)
NPV for Project A
= -5000 + 1646 x PVIFA (6%, 4)
= -5000 + 1646 x 3.465
= $ 704 (Rounded off to nearest integer)
NPV for project B
= -2000 + 701 x PVIFA (6%, 4)
= - 2000 + 701 x 3.465
= $429 (Rounded off to nearest integer)
Calculation of IRR: At IRR, NPV = 0
project A:
NPV at 13%
= -5000 + 1646 x PVIFA (13%, 4)
= -5000 + 1646 x 2.974
= - $105
Therefore,
Applying Interepolation we get,
IRR
= 6% + [(0-704)/(-105 - 704)](13 % - 6%)
= 12.09%
Project B:
at 16%, NPV
= -2000 + 701 x PVIFA (16%, 4)
= -2000 + 701 x 2.798-39
= - $ 39
Therefore,
Applying Interpolation,
IRR = 6% + [(0-429)/(-39-429)] x (16%-6%) = 15.16%
Answer to part c)
Project A and B are both mutually exclusive project with equal duration (project life). At 6% discount rate, Project A generates higher NPV than that generated by Project B and hence project A should be preferred to Project B when the discount rate of 6% is applicable to both the projects.
The IRR of project A is 12.09 %. AT 11% discount rate,
The NPV of Project A
= -5000 + 1646 x 3.102
= -5000 + 5106
= $ 106
The NPV of project B
= -2000 + 701 x 3.102
= -2000 + 2175
= $175
Since the NPV of project B is higher than that of A at a discount rate of 11%, Project B should be preferred to A at k = 11%
Discount Rate NPV 6% 704 IRR 0 13% -105Related Questions
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