IRR — Mutually exclusive projects Bell Manufacturing is attempting to choose the
ID: 2785627 • Letter: I
Question
IRR—Mutually
exclusive projectsBell Manufacturing is attempting to choose the better of two mutually exclusive projects for expanding the firm's warehouse capacity. The relevant cash flows for the projects are shown in the following table:
Project X Project Y
Initial investment $400,000 $310,000
Year(t) Cash inflows (CF Subscript tCFt)
1 $140,000 $120,000
2 $120,000 $140,000
3 $150,000 $85,000
4 $170,000 $60,000
5 $230,000 $70,000
The firm's cost of capital is 16%.
a.Calculate the IRR for each of the projects. Assess the acceptability of each project on the basis of the IRRs.
b.Which project is preferred?
Explanation / Answer
Project X:
CF0 = - 400,000
CF1 = 140,000
CF2 = 120,000
CF3 = 150,000
CF4 = 170,000
CF5 = 230,000
IRR:
400,000 = 140,000/ (1 + r) + 120,000/ (1 + r)2 + 150,000/ (1 + r)3 + 170,000/ (1 + r)4 + 230,000/ (1 + r)5
r = 26.18%
Project Y:
CF0 = - 310,000
CF1 = 120,000
CF2 = 140,000
CF3 = 85,000
CF4 = 60,000
CF5 = 70,000
IRR:
310,000 = 120,000/ (1 + r) + 140,000/ (1 + r)2 + 85,000/ (1 + r)3 + 60,000/ (1 + r)4 + 70,000/ (1 + r)5
r = 18.90%
As IRR of oth of these projects is greater than WACC, we can choose both projects
Part B:
As Project X has more IRR as comapred to Project Y, we will choose Project X
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