Final answer:
To choose between two projects, calculate the IRR and NPV using the cash flows provided. IRR finds the rate at which cash flows' present value equals zero, while NPV discounts future cash flows at a specific rate, here 4.6%, to find their current value. The differing assumptions may lead to different rankings.
Step-by-step explanation:
When choosing between two projects by analyzing their cash flow, two of the most important financial metrics used are the Internal Rate of Return (IRR) and the Net Present Value (NPV).
The IRR is the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal zero. Calculating the IRR involves finding the rate that makes the present value of the future cash flows equal to the initial investment.To calculate the NPV, you would discount the future cash flows of a project back to their present value using your chosen discount rate, which is given as 4.6% in this case. The NPV is the difference between the present value of cash inflows and the present value of cash outflows over time.
IRR and NPV may rank projects differently because they have different reinvestment assumptions and they handle risk differently. The IRR assumes that cash flows are reinvested at the project's own internal rate, while NPV assumes they are reinvested at the firm's cost of capital or discount rate. These differences can lead to different project rankings under certain cash flow scenarios.