Zayas, LLC, has identified the following two mutually exclusive projects: Year C
ID: 2789702 • Letter: Z
Question
Zayas, LLC, has identified the following two mutually exclusive projects:
Year Cash Flow (A) Cash Flow (B)
0 -$78,500 -$78,500
1 $43,000 $21,000
2 $29,000 $28,000
3 $23,000 $34,000
4 $21,000 $41,000
1.What is the IRR for each of these projects? If you apply the IRR decision rule, which project should the company accept? Is this decision necessarily correct?
2. If the required return is 11 percent, what is the NPV for each of these projects? Which project will you choose if you apply the NPV decision rule?
3.Over what range of discount rates would you choose Project A? Project B? At what discount rate would you be indifferent between these two projects? Explain.
Explanation / Answer
1) IRR can be calculated using IRR function in excel or calculator. Based on IRR, we select Project A as it has higher IRR. It is incorrect because Project A has lower NPV.
2) NPV can be calculated using NPV function in excel or calculator with 11% as discount rate. We select Project B as it has higher NPV.
3) Crossover rate is the rate at which we are indifferent between these two projects. Crossover rate can be calculated by computing IRR of the difference in cash flows of two projects. Indifference rate = 12.21%
If discount rate is below 12.21%, we select Project B.
If discount rate is above 12.21%, we select Project A.
A B B - A -78,500 -78,500 0 43,000 21,000 -22,000 29,000 28,000 -1,000 23,000 34,000 11,000 21,000 41,000 20,000 IRR 20.70% 18.73% 12.21% NPV $14,426.54 $15,012.82Related Questions
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