Bell Manufacturing is attempting to choose the better of two mutually exclusive projects for expanding the firm’s warehouse capacity. The relevant cash flows for the projects are shown in the following table:
Initial investment,”$500,000″,”$330,000″
Year,,
1,”$110,000″,”$160,000″
2,”$150,000″,”$120,000″
3,”$170,000″,”$85,000″
4,”$210,000″,”$80,000″
5,”$260,000″,”$60,000″
The firm’s cost of capital is 14%.
a.Calculate the IRR for each of the projects. Assess the acceptability of each project on the basis of the IRRs.
b.Which project is preferred?
Answer:
We have been proovided with the two project, let us find out the IRR of both the project as follow
| Project 1 | |
| Year | Cash Flow |
| 0 | -500,000 |
| 1 | 110000 |
| 2 | 150000 |
| 3 | 170000 |
| 4 | 210000 |
| 5 | 260000 |
Now we will calculateIRR
IRR = (500,000) + 110,000(1+R)+ 150,000(1+R)2+170,000(1+R)3+ 210,000(1+R)4+ 160,000(1+R)5
By trial an error method if we find IRR we get
IRR =20%
| Project 2 | |
| Year | Cash Flow |
| 0 | -330,000 |
| 1 | 160000 |
| 2 | 120000 |
| 3 | 85000 |
| 4 | 80000 |
| 5 | 60000 |
Now we will calculateIRR
IRR = (330,000) + 160,000(1+R)+ 120,000(1+R)2+85,000(1+R)3+ 80,000(1+R)4+ 60,000(1+R)5
By trial an error method if we find IRR we get
IRR =19.76%
Answer :
| Project | IRR |
| Project 1 | 20% |
| Project 2 | 19.76% |
Answer:
Which Project Choose
Choose project 1
