Moerdyk & Co. is considering Projects S and L, whose cash flows are shown below.

Question

Moerdyk & Co. is considering Projects S and L, whose cash flows are shown below. These projects are
mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the
higher IRR, how much value will be forgone? Note that under certain conditions choosing projects on the
basis of the IRR will not cause any value to be lost because the project with the higher IRR will also have the
higher NPV, i.e., no conflict will exist.
WACC: 10.00%
Year 0 1 2 3 4
CFS ?$1,025 $650 $450 $250 $ 50
CFL ?$1,025 $100 $300 $500 $700

Explanation / Answer

IRR of project S: It is the discount rate at which PV of cash inflows = PV of cash outflows PV of CFS at 18% = (650*0.847)+(450*0.718)+(250*0.609)+(50*0.516) = $1051.7 PV of CFS at 20% = (650*0.833)+(450*0.694)+(250*0.579)+(50*0.482) = $1022.6 Using interpolation, IRR = 19.83% IRR of project L: PV of CFS at 14% = (100*0.877)+(300*0.769)+(500*0.675)+(700*0.592) = $1070.3 PV of CFS at 16% = (100*0.862)+(300*0.743)+(500*0.641)+(700*0.552) = $1016 Using interpolation, IRR = 15.67% Decision: Using IRR, we should select project S with higher IRR of 19.83%. NPV of project S: PV of CFS at 10% = (650*0.909)+(450*0.826)+(250*0.751)+(50*0.683) = $1184.45 NPV = PV of cash inflows - PV of cash outflows          =   $1184.45-$1025 = $159.45 NPV of project L: PV of CFS at 10% = (100*0.909)+(300*0.826)+(500*0.751)+(700*0.683) = $1192.3 NPV = PV of cash inflows - PV of cash outflows          =   $1192.3-$1025 = $167.3 Decision: Using NPV, we should select project L with higher NPV. Conclusion: There is a conflict between the decisions given by IRR and NPV. If we select Project S based on IRR, there will be a loss amounting to $167.3-$159.45 = $7.85 IRR of project L: PV of CFS at 14% = (100*0.877)+(300*0.769)+(500*0.675)+(700*0.592) = $1070.3 PV of CFS at 16% = (100*0.862)+(300*0.743)+(500*0.641)+(700*0.552) = $1016 Using interpolation, IRR = 15.67% Decision: Using IRR, we should select project S with higher IRR of 19.83%. NPV of project S: PV of CFS at 10% = (650*0.909)+(450*0.826)+(250*0.751)+(50*0.683) = $1184.45 NPV = PV of cash inflows - PV of cash outflows          =   $1184.45-$1025 = $159.45 NPV of project L: PV of CFS at 10% = (100*0.909)+(300*0.826)+(500*0.751)+(700*0.683) = $1192.3 NPV = PV of cash inflows - PV of cash outflows          =   $1192.3-$1025 = $167.3 Decision: Using NPV, we should select project L with higher NPV. Conclusion: There is a conflict between the decisions given by IRR and NPV. If we select Project S based on IRR, there will be a loss amounting to $167.3-$159.45 = $7.85 PV of CFS at 10% = (650*0.909)+(450*0.826)+(250*0.751)+(50*0.683) = $1184.45 NPV = PV of cash inflows - PV of cash outflows          =   $1184.45-$1025 = $159.45 NPV of project L: PV of CFS at 10% = (100*0.909)+(300*0.826)+(500*0.751)+(700*0.683) = $1192.3 NPV = PV of cash inflows - PV of cash outflows          =   $1192.3-$1025 = $167.3 Decision: Using NPV, we should select project L with higher NPV. Conclusion: There is a conflict between the decisions given by IRR and NPV. If we select Project S based on IRR, there will be a loss amounting to $167.3-$159.45 = $7.85 NPV of project L: PV of CFS at 10% = (100*0.909)+(300*0.826)+(500*0.751)+(700*0.683) = $1192.3 NPV = PV of cash inflows - PV of cash outflows          =   $1192.3-$1025 = $167.3 Decision: Using NPV, we should select project L with higher NPV. Conclusion: There is a conflict between the decisions given by IRR and NPV. If we select Project S based on IRR, there will be a loss amounting to $167.3-$159.45 = $7.85 PV of CFS at 10% = (100*0.909)+(300*0.826)+(500*0.751)+(700*0.683) = $1192.3 NPV = PV of cash inflows - PV of cash outflows          =   $1192.3-$1025 = $167.3 Decision: Using NPV, we should select project L with higher NPV. Conclusion: There is a conflict between the decisions given by IRR and NPV. If we select Project S based on IRR, there will be a loss amounting to $167.3-$159.45 = $7.85

Related Questions

Navigate

• Browse (All)
• Browse M
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.