Consider the following cash flows on two mutually exclusive projects for the Bah
ID: 2779736 • Letter: C
Question
Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporation. Bothe Projects require annual return of 18 percent.
Year Deepwater Fishing New Submarine Ride
0 $-1,040,000 $-2,030,000
1 $460,000 $1,080,000
2 $582,000 $890,000
3 $510,000 $930,000
a-1. Compute the IRR for both Projects. (Dont round intermediate calculations. Enter your answers as a percent rounded 2 decimals)
Deepwater Fishing?
Submarine Ride?
a-2. Based on the IRR, which project would you choose?
b-1. Calculate the Incremental IRR for the cash flows. ( Do not round intermediate calculation. Enter your answers as rounded 2 decimals and as a percent.)
Deepwater Fishing?
Submarine Ride?
b-2. Based on the Incremental IRR, Which project would you choose?
c-1. Compute the NPV for both project. (Do not round intermediate calculations. Enter your answers as a dollar and rounded 2 decimals.
Deepwater Fishing $
Submarine Ride $
c-2 Based on the NPV, which project should you choose?
c-3. Is the NPV decision consistent with the incremental IRR Rule?
Explanation / Answer
IRR is the rate at which NPV = 0
NPV is calculated by discounting the cashflows
PV = C/(1+r)^n
C - Cashflow
r - Discount rate
n - years to the cashflow
Deepwater fishing:
NPV = -1040000 + 460000/(1+IRR)^1 + 582000/(1+IRR)^2 + 510000/(1+IRR)^3 = 0
IRR = 22.55%
New submarine ride:
NPV = -2030000+ 1080000/(1+IRR)^1 + 890000/(1+IRR)^2 + 930000/(1+IRR)^3 = 0
IRR = 20.85%
a-2 Base on IRR rule, you select Deep water fishing, as the IRR is higher than New submarine ride.
b-1
To calculate incremental IRR cashflows of the smaller project is subtracted from the larger project.
Now find the irr:
NPV = -990000 + 620000/(1+IRR)^1 + 308000/(1+IRR)^2 + 420000/(1+IRR)^3 = 0
Incremental IRR = 18.84%
b-2 You accept the larger project if the incremental IRR is greater than the discount rate. Since 18.84% is greater than the discount rate, Submarine ride is accepted.
c-1
Deepwater fishing:
NPV = -1040000 + 460000/(1+0.18)^1 + 582000/(1+0.18)^2 + 510000/(1+0.18)^3
NPV = $78215.59
New submarine ride:
NPV = -2030000+ 1080000/(1+0.18)^1 + 890000/(1+0.18)^2 + 930000/(1+0.18)^3
NPV = $90465.09
c-2 Based on NPV rule, Submarine ride should be chosen as the NPV is higher than deep water fishing
c-3 Yes. NPV decision is consistent with the incremental IRR rule.
Year(n) Deep water fishing Submarine Incremental cashflows = Submarine - deep water 0 -1040000.00 -2030000.00 -990000.00 1 460000.00 1080000.00 620000.00 2 582000.00 890000.00 308000.00 3 510000.00 930000.00 420000.00Related Questions
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