Consider two mutually exclusive R&D projects that company XYZ is considering. As
ID: 2699255 • Letter: C
Question
Consider two mutually exclusive R&D projects that company XYZ is considering. Assume the discount rate is 15% and the minimum acceptable IRR is 25 per cent.
Year A B
0 -100,000 -200,000
1 50,000 60,000
2 50,000 60,000
3 40,000 60,000
4 30,000 100,000
5 20,000 200,000
SUM $90,000 $280,000
Calculate NPV, IRR, Incremental IRR, and PI for both projects.
Explanation / Answer
Hi,
Please find the answer as follows:
Part A:
Project A = -100000 + 50000/(1+.15)^1 + 50000/(1+.15)^2 + 40000/(1+.15)^3 + 30000/(1+.15)^4 + 20000/(1+.15)^5 = 34682.23
Project B = -200000 + 60000/(1+.15)^1 + 60000/(1+.15)^2 + 60000/(1+.15)^3 + 100000/(1+.15)^4 + 200000/(1+.15)^5 = 93604.18
Part B:
Put NPV as 0 to calculate IRR
Project A:
0= -100000 + 50000/(1+r)^1 + 50000/(1+r)^2 + 40000/(1+r)^3 + 30000/(1+r)^4 + 20000/(1+r)^5
Calculate r using Trial and Error Method
IRR for Project A = 31.28%
Project B:
0 = -200000 + 60000/(1+.15)^1 + 60000/(1+.15)^2 + 60000/(1+.15)^3 + 100000/(1+.15)^4 + 200000/(1+.15)^5
Calculate r using Trial and Error Method
IRR for Project B: 29.54%
Part C:
Incremental IRR = 28.60% ( Calculated with the use of Incremental Cash Flows)
Part D:
Profitability Index = PV of Cash Inflows/Initial Investment
Project A =134682/100000 = 1.346 or 1.35
Project B = 293604/200000 = 1.468 or 1.47
Thanks.
Project A Project B Incremental Cash Flows -100000 -200000 -100000 50000 60000 10000 50000 60000 10000 40000 60000 20000 30000 100000 70000 20000 200000 180000