Question

You are considering two independent projects. Project A has an initial cost of $125,000 and cash inflows of $46,000, $79,000, and $51,000 for Years 1 to 3, respectively. Project B costs $135,000 with expected cash inflows for Years 1 to 3 of $50,000, $30,000, and $100,000, respectively. The required return for both projects is 16 percent. Based on IRR, you should:

a. Accept both projects.
b. Accept Project A and reject Project B.
c. Accept Project B and reject Project A.
d. Reject both projects.
e. Accept either one of the projects, but not both

Answer 1

Answer:

b. Accept Project A and reject Project B.

Explanation:

To verify project viability at a required return rate of 16%, simply calculate the project's net present value at a rate of 16%. If the NPV is positive, then the project should be accepted, otherwise it should be rejected.

Project A:

$NPV = -\ 125,000 +\frac{\ 46,000}{(1+0.16)} +\frac{\ 79,000}{(1+0.16)^2} +\frac{\ 51,000}{(1+0.16)^3}\\NPV =\ 6,038.58$

Project A should be accepted.

Project B:

$NPV = -\ 135,000 +\frac{\ 50,000}{(1+0.16)} +\frac{\ 30,000}{(1+0.16)^2} +\frac{\ 100,000}{(1+0.16)^3}\\NPV =-\ 5,535.89$

Project B should be rejected.