Garage, Inc., has identified the following two mutually exclusive projects: Cash
ID: 2778866 • Letter: G
Question
Garage, Inc., has identified the following two mutually exclusive projects: Cash Flow Year Cash Flow (A) (B) 29,400 29,400 14,800 4,500 12,700 10,000 9,400 15,600 5,300 17,200 a-1 What is the IRR for each of these projects? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) IRR Project A Project B a-2 Using the IRR decision rule, which project should the company accept? O Project A O Project B a-3 ls this decision necessarily correct? O Yes No b-1 If the required return is 12 percent, what is the NPV for each of these projects? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) NPV Project A Project B b-2 which project will the company choose if it applies the NPV decision rule? O Project A O Project B c. At what discount rate would the company be indifferent between these two projects? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Discount rateExplanation / Answer
IRR is the rate at which the net present value of the cash flow is equal to the initial return. This can be calculated by the given formula:
0 = (investment) + CF1/ (1+IRR)1+CF2/(1+IRR)2+CFN/(1+IRR)N
Project A
At 19.47% the initial investment is equal to the NPV of the project.
Project B
At 17.94% of IRR the initial investment is equal to the NPV so the IRR is 17.94%
A2
The project with the higher IRR is chosen by the company. In this case based on the IRR rule project A has the highest IRR, so it will choose project A.
AC:
No the decision is not correct since IRR is the way to calculate the anticipated interenal rate of the firm rather than the dollar amount. As we have seen that the decission is different in case of NPV method, NPV gives the correct picture of the investment.
B1
Net Present value is calculated by the given formula:
Initial investment - sum of the PV of the cash flows
PV Factor can be calculated by the following formula
PV = 1 / (1+R)^n
Where R is cost of capital or discount rate
and n is number of year
Project A
Project B
B-2
Based on the calculation above for the NPV company will chose project B since the NPV is higher in the project B.
B-3
The discount rate where the NPV is zero is where the company would be indifferent between these two projects. As we have seen that the discount rate at which the project A has zero NPV is 19.47 and for project B is 17.94. The company will be indifferent at these discount rates.
Hope this helps.
Year Cash Flow PV Factor =1 / (1+R)^n Present Value = Cash Flow * PV factor 0 ($29,400) 1.000000 ($29,400.00) 1 $14,800 0.837030 $12,388.05 2 $12,700 0.700620 $8,897.87 3 $9,400 0.586440 $5,512.53 4 $5,300 0.490868 $2,601.60 Net Present value = Total PV - Intial Investment $0.00
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