If an independent project with conventional, or normal, cash flows is being anal

Question

If an independent project with conventional, or normal, cash flows is being analyzed, the net present value (NPV) and internal rate of return (IRR) methods_____ agree. Projects Y and z are mutually exclusive projects. Their cash flows and NPV profiles are shown as follows. If the weighted average cost of capital (WACC) for each project is 14%, do the NPV and IRR methods agree or conflict? The methods agree. The methods conflict. A key to resolving this conflict is the assumed reinvestment rate. The NPV calculation implicitly assumes that intermediate cash flows are reinvested at the _____________________ , and the IRR calculation assumes that the rate at which cash flows can be reinvested is the____. As a result, when evaluating mutually exclusive projects, the_____ is usually the better decision criterion.

Explanation / Answer

1)

Both

2)

NPV of project Y = -1,500 + 200 / ( 1 + 0.06)1 + 400 / ( 1 + 0.06)2 + 600 / ( 1 + 0.06)3 + 10,00 / ( 1 + 0.06)4  

NPV of project Y = $340.54

NPV of project Z = -1,500 + 900 / ( 1 + 0.06)1 + 600 / ( 1 + 0.06)2 + 300 / ( 1 + 0.06)3 + 200 / ( 1 + 0.06)4  

NPV of project Z = $293.36

IRR is the rate of return that makes NPV equal to 0

We use trial and error method to find IRR for both projects

Let's try R as 13.49

0 = -1,500 + 200 / ( 1 + R)1 + 400 / ( 1 + R)2 + 600 / ( 1 + R)3 + 1000 / ( 1 + R)4

0 = 0

Therfore IRR of project X is 13.49%

Let's try 17.07

0 = -1,500 + 900 / ( 1 + R)1 + 600 / ( 1 + R)2 + 300 / ( 1 + R)3 + 200 / ( 1 + R)4  

0 =0

Therefore IRR for project Z is 17.07%

The methods conflict

3)

required rate of return

4)

internal rate of return (IRR)

5)

NPV method

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