Consider the following two mutually exclusive projects: A and B. Both projects require an annual rate of return of 15%. The cash flows for the two projects are as below:
Year Project A Project B
0 -600,000 -1,800,000
1 270,000 1,000,000
2 350,000 700,000
3 300,000 900,000
Calculate the IRR (using the Excel function, “=IRR”) for each project. Based on the IRR, which one should be your choice?
Calculate the NPV for each project, using your calculator (please also use the Excel function to double check your result). Based on the NPV rule, which one should you recommend?
Is there a conflict between the two rules? If yes, which project should be taken?
2. Tom is considering three different investment plans--A, B, and C--that his broker has offered to him. Each plan requires the same amount of investment but provides different cash flows as follows:
End of Year A B C
1 $200 0 $500
2 200 0 0
3 200 0 0
4 200 200 500
5 0 200 0
6 0 200 0
7 0 200 0
8 0 200 500
Because Tom only has enough savings for one investment, his broker has proposed the third alternative to be, according to his expertise, “the best in town.” However, Tom questions his broker’s recommendation and asks you for help. The required rate of return for the three investments is the same: 10%. What is Tom’s best alternative? Why? [Hints: Compare the PV of the future cash flows.]