Consider the following cash flows on two mutually exclusive projects for the Bah
ID: 2790814 • Letter: C
Question
Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporation. Both projects require an annual return of 16 percent.
a-1. Compute the IRR for both projects. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
a-2. Based on the IRR, which project should you choose?
Submarine Ride
Deepwater Fishing
b-1. Calculate the incremental IRR for the cash flows. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Incremental IRR %
b-2. Based on the incremental IRR, which project should you choose?
Submarine Ride
Deepwater Fishing
c-1. Compute the NPV for both projects. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
c-2. Based on the NPV, which project should you choose?
Submarine Ride
Deepwater Fishing
c-3. Is the NPV rule consistent with the incremental IRR rule?
No
Yes
Year Deepwater Fishing New Submarine Ride 0 $ 985,000 $ 1,920,000 1 405,000 970,000 2 538,000 835,000 3 455,000 820,000Explanation / Answer
BAHAMAS RECREATION CORPORATION: a-1) DEEPWATER FISHING: Year Cash flow PVIF at 20% PV at 20% PVIF at 19% PV at 19% 0 -985000 1.00000 -985000.00 1.00000 -985000.00 1 405000 0.83333 337500.00 0.84034 340336.13 2 538000 0.69444 373611.11 0.70616 379916.67 3 455000 0.57870 263310.19 0.59342 270004.20 -10578.70 5257.00 IRR = 19+5257/(5257+10578.70) = 19.33% NEW SUBMARINE RIDE: Year Cash flow PVIF at 18% PV at 18% PVIF at 19% PV at 19% 0 -1920000 1.00000 -1920000.00 1.00000 -1920000.00 1 970000 0.84746 822033.90 0.84034 815126.05 2 835000 0.71818 599684.00 0.70616 589647.62 18.027029 3 820000 0.60863 499077.32 0.59342 486600.97 795.21 -28625.36 IRR = 18+795.21/(795.21+28625.36)= 18.02 a-2) Based on IRR the project 'DEEPWATER FISHING' should be selected, as it has higher IRR> b-1) INCREMENTAL IRR (NEW SUB RIDE-DEEPWATER FISHING) Year Cash flow PVIF at 17% PV at 17% PVIF at 16% PV at 16% 0 -935000 1.00000 -935000.00 1.00000 -935000.00 1 565000 0.85470 482905.98 0.86207 487068.97 2 297000 0.73051 216962.52 0.74316 220719.38 3 365000 0.62437 227895.25 0.64066 233840.05 -7236.24 6628.40 INCREMENTAL IRR = 16+6628.40/(7236.24+6628.40) = 16.48% b-2) As the Incremental IRR>Required return, NEW SUB RIDE is to be chosen. C-1) DEEPWATER FISHING: Year Cash flow PVIF at 16% PV at 16% 0 -985000 1 -985000.00 1 405000 0.86207 349137.93 2 538000 0.74316 399821.64 3 455000 0.64066 291499.24 NPV = 55458.81 NEW SUBMARINE RIDE: Year Cash flow PVIF at 16% PV at 16% 0 -1920000 1 -1920000.00 1 970000 0.86207 836206.90 2 835000 0.74316 620541.02 3 820000 0.64066 525339.29 NPV = 62087.21 C-2) Based on NPV, Project 'NEW SUBMARINE RIDE' should be selected as it has the higher NPV. C-3) YES, the NPV rule is consistent with the INCREMENTAL IRR rule.
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