Consider the two mutually exclusive investment projects given in the table below

Question

Consider the two mutually exclusive investment projects given in the table below for which MARR =20%. On the basis of the IRR criterion, which project would be selected under an infinite planning horizon with project repeatability likely? E Click the icon to view the cash flows for the investment projects The rate of return on the incremental investment is %. (Round to one decimal place.) More Info Net Cash Flow Project A Project B - $4,000 - $9,500 1,500 2,500 2,500 26.23% 7,000 7,000 IRR 30.25% Print Done

Explanation / Answer

Lets say NPV of A be A and NPV of B be B

Incremental NPV= (B+B/(1+r)^3+B/(1+r)^6................)-(A+A/(1+r)^5+A/(1+r)^9............)

=B/(1-1/(1+r)^3)-A/(1-1/(1+r)^5)

B=-9500+7000/(1+r)+7000/(1+r)^2

A=-4000+1500/(1+r)+2500/(1+r)^2+2500/(1+r)^3

Hence, Incremental NPV=(-9500+7000/(1+r)+7000/(1+r)^2)/(1-1/(1+r)^3)-(-4000+1500/(1+r)+2500/(1+r)^2+2500/(1+r)^3)/(1-1/(1+r)^5)

IRR is where the above NPV is zero

0=(-9500+7000/(1+r)+7000/(1+r)^2)/(1-1/(1+r)^3)-(-4000+1500/(1+r)+2500/(1+r)^2+2500/(1+r)^3)/(1-1/(1+r)^5)

r=33.357%

IRR=33.357%

As Incremental rate of return is greater than MARR of 20%, B should be accepted.

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