Internal rate of return

You are a financial analyst for the Waffle Company. The director of capital budgeting has asked you to analyze two proposed capital investments, Projects A and B. Each project has a cost of $50,000, and the cost of capital for each is 10%.

The projects’ expected net cash flows are as follows:

Expected Net Cash Flows
Year Project A Project B
0 ($50,000) ($50,000)
1 25,000 15,000
2 20,000 15,000
3 10,000 15,000
4 5,000 15,000
5 5,000 15,000
  1. Calculate each project’s payback period, net present value (NPV), internal rate of return (IRR), modified internal rate of return (MIRR), and profitability index (PI).
  2. Which project will you select if your decision was based solely on the project’s payback period?
  3. Which project or projects should be accepted if they are independent?
  4. Which project should be accepted if they are mutually exclusive?
  5. d. How might a change in the cost of capital produce a conflict between the NPV and IRR rankings of these two projects? Would this conflict exist if r were 6%? (Hint: Plot the NPV profiles.)

Question 2

Marvin Industries must choose between an electric-powered and a coal-powered forklift machine for its factory. Because both machines perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered machine will cost more, but it will be less expensive to operate; it will cost $102,000, whereas the coal-powered machine will cost $69,500. The cost of capital that applies to both investments is 10%. The life for both types of machines is estimated to be 6 years, during which time the net cash flows for the electric-powered machine will be $26,150 per year, and those for the coal-powered machine will be $20,000 per year. Annual net cash flows include depreciation expenses.

  1. Calculate the NPV and IRR for each type of machine, and decide which to recommend.