Question

Sun Lee's is considering two mutually exclusive projects that have been assigned the same discount rate of 10.5 percent. Project A has an initial cost of $54,500, and should produce cash inflows of $16,400, $28,900, and $31,700 for Years 1 to 3, respectively. Project B has an initial cost of $79,400, and should produce cash inflows of $0, $48,300, and $42,100, for Years 1 to 3, respectively. What is the incremental IRR

Answer 1

Answer:

incremental IRR 15,404%

Project A is better than project B

Explanation:

the incremental IRR will be the internal rate of return after subtracting the cashflow of the smaller project from the bigger project.

Project A    Project B   Difference

F0      -54500 -79400 -24900

F1         16400          0  -16400

F2       28900 48300   19400

F3         31700 42100   10400

Now, we calcualte the internal rate of return of this "differential" project:

We have a project that reuqires an investment of 24,900

Then another of 16,400 and then, we receive 19,400 and 10,400

we use excel IRR function and get -15.4035%

As the differential IRR is negative can determnate the better project which is A