Q1. Project Alpha requires an outlay of $10,000 immediately. Project Alpha has a

Question

Q1.

Project Alpha requires an outlay of $10,000 immediately. Project Alpha has a 1-year life and is
expected to produce a net cash flow at the end of one year of $20,000. Project Beta, a mutually
exclusive alternative to Alpha, requires an outlay of $20,000 immediately. It, too, is expected to
have a 1-year life and to produce a net cash flow at the end of one year of $35,000.

Compare the internal rate of return for both projects. Compute the NPV for both projects, using a
cost of capital of 10 percent.

Which projects should be undertaken?


Q2



Consider the following projects X and Y where the firm can choose only once. Project X costs $600
and has cash flows of $400 in each of the next two years. Project B also costs $ 600 and generates
cash flows $500 and $275 for the next two years, respectively. Sketch a net present value profile
(graphs) for each of these projects. For graphs you may use approximation

Which project should the firm choose if the cost of capital is 10 percent? What if the cost of capital
is 25 percent?

Explanation / Answer

Q1 Project Alpha NPV = -$10,000 +$20,000/1.1 = 8181.818 IRR, -$10,000 +$20,000/(1+r) = 0 r =100% Project Beta PV = -$20,000 +$35,000/1.1 = 11818.1818 IRR, -$20,000 +$35,000/(1+r) = 0 r =75% Project Beta should be chosen with higher NPV

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