Big Company is evaluating two projects, Project A and Project B. Both projects a
ID: 2802055 • Letter: B
Question
Big Company is evaluating two projects, Project A and Project B. Both projects are of equal risk. Big Company has a WACC of 10%. The expected free cash flows of the projects are as follows
A. Compute the Internal Rate of Return of Project “A”.
B. The Internal Rate of Return of Project “B” is 36.15%. If Projects “A” and “B” are independent, considering only at the IRR method, which project(s) should Big Company proceed with? Explain your answer
C. The Internal Rate of Return of Project “B” is 36.15%. If project(s) “A” and “B” mutually exclusive, considering only at the IRR method, which project(s) should Big Company proceed with?
Period Annual Cash Flows Project A Annual Cash Flows Project B 0 (25,000) (25,000) 1 5,000 20,000 2 10,000 10,000 3 15,000 8,000 4 20,000 6,000Explanation / Answer
Part A
CF0 = -25,000
CF1 = 5,000
CF2 = 10,000
CF3 = 15,000
CF4 = 20,000
To calculate Internal Rate of Return we need to take help of excel.
We will type above cash flows in a excell worksheet in following cells:
A1 = -25,000
A2 = 5,000
A3 = 10,000
A4 = 15,000
A5 = 20,000
Now in Cell A6, we will apply formula = IRR(A1:A5,5%)
We will get IRR = 27.27%
Part B:
As both projects are independent, firm can choose both projects. The IRR of both projects is greater than the minimum required WACC. So we can aacept both the projects.
In independent projects, selection of one project does not hamper selection of other projects. Selection of any project is depend on the underlying criteria which is IRR in this case.
Part C
In the case of mutual exclusive projects, firm can only choose a single project. As IRR of project B is more than project A we will choose project B.
In mutual exclusive projects, selection of one project does hamper selection of other projects.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.