Higher Ground Company is presented with the following two mutually exclusive pro
ID: 2773018 • Letter: H
Question
Higher Ground Company is presented with the following two mutually exclusive projects. The required return for both projects is 15 percent.
What is the IRR for each project? (Do not include the percent signs (%). Enter rounded answers as directed, but do not use the rounded numbers in intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)
What is the NPV for each project? (Do not include the dollar signs ($). Enter rounded answers as directed, but do not use the rounded numbers in intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)
Higher Ground Company is presented with the following two mutually exclusive projects. The required return for both projects is 15 percent.
Explanation / Answer
Answer (a)
Project M = IRR 35%
Project N = IRR 24%
Answer (b)
NPV of Project M = $ 59,530.30
NPV of Project N = $ 63,095.40
Answer (c)
As NPV is positive both the projects are acceptable.
Working
Year
Project M
Project N
0
-$141,000
-$364,000
1
64,400
148,000
2
82,400
189,000
3
73,400
133,000
4
59,400
119,000
Required Return = 15% or 0.15
If r is the required rate of return and CF1,CF2,CF3,CF4 are cash flows in years 1,2,3,4, then NPV can be calculated using the formula
NPV = - Initial Investment + CF1 / 1+r + CF2 / (1+r)^2 + CF3 / (1+r)^3 + CF4/(1+r)^4
The rate of return r will be known as Internal Rate of Return (IRR) of the project if NPV= 0. That is
- Initial Investment + CF1 / 1+r + CF2 / (1+r)^2 + CF3 / (1+r)^3 + CF4/(1+r)^4 = 0
Calculation of IRR for Project M
-$ 141,000 + 64,400 / 1+r + 82,400 / (1+r)^2 + 73,400 / (1+r)^3 + 59,400/(1+r)^4 = 0
Using IRR function in Excel the value of r for Project M is 35%
Calculation of IRR for Project N
-$364,000+ 148,000 / 1+r + 189,000 / (1+r)^2 + 133,000 / (1+r)^3 + 119,000/(1+r)^4 = 0
Using IRR function in Excel the value of r for Project N is 24%
Required Return = 15% or 0.15
NPV = - Initial Investment + CF1 / 1+r + CF2 / (1+r)^2 + CF3 / (1+r)^3 + CF4/(1+r)^4
Calculation of Discounting Factor
1/(1.15) = 0.8696
1/1.15^2 = 1/1.3225 = 0.7561
1/1.15^3 = 1/1.520875 = 0.6575
1/1.15^4 = 1/1.74900625 = 0.5718
Year
Discounting factor
Project M
Discounted Flow
Project N
Discounted Flow
1
0.8696
64,400
56,002.24
148,000
128,700.80
2
0.7561
82,400
62,302.64
189,000
142,902.90
3
0.6575
73,400
48,260.50
133,000
87,447.50
4
0.5718
59,400
33,964.92
119,000
68,044.20
Total Discounted Cash Flow
200,530.30
427,095.40
NPV of Project M = -$ 141,000 + $ 200,530.30 = $ 59,530.30
NPV of Project N = - $ 364,000 + $ 427,095.40 = $ 63,095.40
Year
Project M
Project N
0
-$141,000
-$364,000
1
64,400
148,000
2
82,400
189,000
3
73,400
133,000
4
59,400
119,000