Project A and Project B have a cost of $24,000,000 today. Project A will have ca

Question

Project A and Project B have a cost of $24,000,000 today. Project A will have cash flows of $10,000,000 per year for three years, while Project B will have cash flows of $15,000,000 the first year, $10,000,000 the second year, and $7,000,000 the third year.

Calculate the NPV and the IRR for Project A using a 12% cost of capital and show your work by using TWO of the following methods: (1) using the formula, (2) identifying all variables using the calculator’s function keys, (3) using the steps on the calculator to calculate NPV and IRR. Note it is an annuity since the cash flows are the same.

Calculate the NPV and the IRR for Project B using a 12% cost of capital and show your work by using TWO of the following methods: (1) using the formula, (2) identifying all variables using the calculator’s function keys, (3) using the steps on the calculator to calculate NPV and IRR. Note this project has different cash flows.

Should A, B, both A and B, or neither be accepted if the projects are independent. Circle your choice.

Should A, B, both A and B, or neither be accepted if the projects are mutually exclusive. Circle your choice

Explanation / Answer

Cashflows for project A

NPV = -24000000+ 10000000/(1+.12)^1 + 10000000/(1+.12)^2 + 10000000/(1+.12)^3 = 16350.61

IRR is th rate return at which the NPV become IRR

So by hit and trial using excel IRR woudl be 12.04%

For Project B

NPV = -24000000+ 15000000/(1+.12)^1 + 10000000/(1+.12)^2 + 7,000,000/(1+.12)^3 = 2095765.76

IRR =18.46%

ndependent Projects

Independent projects are projects in which decision regarding acceptance of one project does not affect decision regarding others.

Since all independent projects can all be accepted if they add value, NPV and IRR conflict doesn’t arise. The company can accept all projects with positive NPV.

Hence as both have irr > acceptable returns and nov as positive both will accpeted

utually Exclusive Projects

Mutually exclusive projects are projects in which acceptance of one project excludes the others from consideration. In such a scenario the best project is accepted. NPV and IRR conflict, which can sometimes arise in case of mutually exclusive projects, becomes critical. The conflict either arises due to the relative size of the project or due to the different cash flow distribution of the projects.

Since NPV is an absolute measure, it will rank a project adding more dollar value higher regardless of the original investment required. IRR is a relative measure, and it will rank projects offering best investment return higher regardless of the total value added.

Therfefore as NPV of project B is higher it would be accepted

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