The following table shows the cash flows of two projects from year 0 to year 4.

ID: 2798660 • Letter: T

Question

The following table shows the cash flows of two projects from year 0 to year 4.

Please finish the following tasks:

(a) Solve the IRR of EACH project (3 points)

(b) Solve the NPV of EACH project when required return is 15% (3 points)

(d) Solve the crossover rate for the two projects (5 points)

(e) Explain how to use the crossover rate to choose the better project, when Project A and Project B are mutually exclusive to each other. (3 points)

(f) List the advantages and disadvantages of using IRR to make capital budgeting decisions, especially when compared to using NPV. (4 points)

Project A Project B Year 0 -100 -135 Year 1 50 60 Year 2 50 80 Year 3 50 60 Year 4 50 50

Project A:

IRR is calculated as :

0 = - 100 + 50/(1+IRR) + 50/(1+IRR)2 + 50/(1+IRR)3 + 50/(1+IRR)4

On Solving we get IRR = 34.90%

NPV is calculated as @ 15%

- 100 + 50/(1+0.15) + 50/(1+0.15)2 + 50/(1+0.15)3 + 50/(1+0.15)4

= 142.75 - 100 = 42.75

NPV is calculated as @ 30%

- 100 + 50/(1+0.30) + 50/(1+0.30)2 + 50/(1+0.30)3 + 50/(1+0.30)4

= 108.31 - 100 = 8.31

Project B:

IRR is calculated as :

0 = - 135 + 60/(1+IRR) + 80/(1+IRR)2 + 60/(1+IRR)3 + 50/(1+IRR)4

On Solving we get IRR = 31.50%

NPV is calculated as @ 15%

- 135 + 60/(1+0.15) + 80/(1+0.15)2 + 60/(1+0.15)3 + 50/(1+0.15)4

= 180.70 - 135 = 45.70

NPV is calculated as @ 30%

- 100 + 60/(1+0.30) + 80/(1+0.30)2 + 60/(1+0.30)3 + 50/(1+0.30)4

= 138.31 - 135 = 3.30

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