ABC Co.’s assets consist of $20 thousand in cash and three investment projects.

Question

ABC Co.’s assets consist of $20 thousand in cash and three investment projects. The firm has no debt outstanding. The company can borrow and lend at 8% per year. Each project lasts for only one year. The table below lists the cash flows from the projects at the initial date (t = 0) and at the end of the year (t = 1). Cash outflows are listed as negative numbers, while cash inflows are listed as positive. All figures are in thousands of dollars.

Answer the following:

1. Calculate the Internal Rate of Return (IRR) of each project.

2. Which projects should the firm invest in and why?

3. How much would you pay today, before any investments have been made, to buy this firm?

Explanation / Answer

Let IRR be x

Project X

0=-100+110/(1+x)

100=110/(1+x)

100+100x=110

x=10/100

x=10%

Project Y=+200-224/(1+x)

200+200x=224

x =12%

Project Z

0=-80+84/(1=x)

80+80x=84

x =5%

WE WILL GO FOR PROJECT Y WITH HIGHEST IRR

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