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:

We use excel or a spreadsheet to calculate this ratio.

See document attached.

Cash flow will solve this problem.

At moment 0 we have the investment cost or initial cost, in this case $125,000 or $135,000. From period 1 to period 3, we have different  incomes. Then, we calculate the Net cash flow that is the difference between benefits and cost.

We use all the result (positive and negative) in Net cash flow to get the IRR.  

Project A

Internal Rate of Return (IRR) 18,86%

Project B

Internal Rate of Return (IRR) 13,78%

So we should accept Project A and reject Project B,  because in project A the IRR is bigger of required return ( 16%),  we reject project B because the IRR is smaller.