Consider the three projects below. Notice that the cash flows from B and C are 1
ID: 2706180 • Letter: C
Question
Consider the three projects below. Notice that the cash flows from B and C are 1,800 and 1,200 forever. The project C cannot start until period 1. All cash flows happen at the end of the period.
a) Compute the NPV and the IRR for all three projects, if the discount rate is 10%.
b) If you have to decide between projects A and B only, which one would you take?
Why?
c) If this example is presented to real world managers, they tend to prefer project A.
Can you think of any reason why managers behave this way?
Consider the three projects below. Notice that the cash flows from B and C are 1,800 and 1,200 forever. The project C cannot start until period 1. All cash flows happen at the end of the period. Compute the NPV and the IRR for all three projects, if the discount rate is 10%. If you have to decide between projects A and B only, which one would you take? If this example is presented to real world managers, they tend to prefer project A. Can you think of any reason why managers behave this way?Explanation / Answer
1)
Project A
NPV of A = -9000 + 6000/1.1 + 5000/1.1^2 + 4000/1.1^3 =$3,592.04
For IRR, NPV =0
-9000 + 6000/(1+IRR) + 5000/(1+IRR)^2 + 4000/(1+IRR)^3 =0
IRR = 33.33%
Project B
NPV of B = -9000 + 1800/(10%) =$9000
For IRR, NPV =0
-9000 + 1800/(IRR) =0
IRR = 20%
Project C
NPV of C= -6000/1.1 + (1200/(10%))/1.1 =$5454.55
For IRR, NPV =0
= -6000/(1+IRR) + (1200/(IRR))/(1+IRR)= =0
IRR = 20%
2)Project A becuase it has higher NPV than Project B
3) Because Project A has higher NPV and shorter payabk period