Consider the following cash flows on two mutually exclusive projects for the Bah

Question

Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporation. Both projects require an annual return of 18 percent.

a-1. Compute the IRR for both projects. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

a-2. Based on the IRR, which project should you choose?

Submarine Ride

Deepwater Fishing

b-1. Calculate the incremental IRR for the cash flows. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Incremental IRR             %

b-2. Based on the incremental IRR, which project should you choose?

Submarine Ride

Deepwater Fishing

c-1. Compute the NPV for both projects. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

c-2. Based on the NPV, which project should you choose?

Submarine Ride

Deepwater Fishing

c-3. Is the NPV rule consistent with the incremental IRR rule?

No

Yes

Year Deepwater Fishing New Submarine Ride 0 ?$ 1,035,000 ?$ 2,020,000 1 455,000 1,070,000 2 578,000 885,000 3 505,000 920,000

Explanation / Answer

SOLUTION:

a1) CALCULATION OF IRR

PROJECT DEEPWATER FISHING ($)

using interpolation technique, IRR=

10% + 10% * 234700/197158 = 22.27%

(197158= 234700-37542)

PROJECT SUBMARINE RIDE ($)

using interpolation technique, IRR=

10% + 10% * 373675/ 391855 = 19.53% = 20%

(391855= 373675+18180)

thus,

a2)

based on IRR, we should choose PROJECT DEEPWATER FISHING since it has greater IRR.

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b1) INCREMENTAL IRR (PROJECT 2 INCREMENTAL TO PROJECT 1)

IRR for INCREMENTAL CASH FLOWS= 18.64%

b2) based on incremental IRR , we should choose project SUBMARINE RIDE due to higher cash flows and thus higher IRR of 18.64%.

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c1) CALCULATION OF NPV

PROJECT DEEPWATER FISHING

PROJECT SUBMARINE RIDE

c2) based on NPV we should choose project SUBMARINE RIDE due to higher NPV.

c3)YES, since final answer under both the methods is same project subarine ride.

Year cash flows rate= 10% present value rate= 20% present value 0 (1035000) 1 (1035000) 1 (1035000) 1 455000 0.909 413595 0.833 379015 2 578000 0.826 4766850 0.694 401132 3 505000 0.751 379255 0.579 292395 NET 234700 37542

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