Kerron Company is presented with the following two mutually exclusive projects.
ID: 2756031 • Letter: K
Question
Kerron Company is presented with the following two mutually exclusive projects. The required return for both projects is 17 percent. Year Project M Project N 0 –$145,000 –$360,000 1 64,000 150,000 2 82,000 185,000 3 73,000 135,000 4 59,000 115,000 Required: (a) What is the IRR for each project? (Do not round intermediate calculations. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).) IRR Project M % Project N % (b) What is the NPV for each project? (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).) NPV Project M $ Project N $ (c) Which, if either, of the projects should the company accep
Explanation / Answer
A.
IRR : Internal Rate of Return
0 = CF0 + CF1/(1+r)1 + CF2/(1+r)2 + CF3/(1+r)3 + CF4/(1+r)4
Project M:
145,000 = 64000/(1+IRR)1 + 82000 /(1+IRR)2 + 73000/(1+IRR)3 + 59000/(1+IRR)4
= 32.73%
Project N:
36,000 = 150,000/(1+IRR)1 + 185,000/(1+IRR)2 + 135,000/(1+IRR)3 + 115,000/(1+IRR)4
= 24.12%
The IRR decision rule implies we accept project M because the IRR for M is greater than the IRR for N.
B.
NPV: Net Present Value
NPV = (INVESTMENT) + CF1/(1+k)1 + CF2/(1+k)2 + CF3/(1+k)3 + CF/(1+k)4
Project M:
NPV = -145,000 + 64000/(1+17)1 + 82000/(1+17)2 + 73000/(1+17)3 + 59000/(1+17)4
NPV = 46,667.37
Project N:
NPV = -360,000 + 150,000/(1+17)1 + 185000/(1+17)2 + 135000/(1+17)3 + 115000/(1+17)4
NPV = 49,009.92
The NPV criterion implies we accept project N because project N has a higher NPV than project M
C.
Accept project M since the NPV is higher. IRR cannot be used to rank mutually exclusive projects.
Year Project M Project N 0 -145,000 -360,000 1 64,000 150,000 2 82,000 185,000 3 73,000 135,000 4 59,000 115,000
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