Question

You are evaluating the following two investment opportunities: Project A: This project requires $2,000 upfront, and pays you $500 at the end of each of the first 2 years, and an additional lump-sum of $1200 at the end of year 3. Project B: This project requires $2,000 upfront, and pays you $600 at the end of each of the first 2 years, and an additional lump-sum of $1000 at the end of year 3. Which project has a smaller IRR, and which project is more attractive?

Answer 1

The project A has a smaller IRR, and the project B is more attractive

Step-by-step explanation:

Solution

Solve for Project A:

Now,

Let assume that the IRR be x

Hence,

The Present Value of Outflows of Cash Outflows= The Present Value of Inflows of Cash

Thus,

2000 =500/(1.0x) +500/ (1.0x)^2 +1200/(1.0x)^3

Or we say x= 4.223%

Therefore the IRR is 4.223%

For project B:

Let assume that the IRR be y.

Thus,

The Present Value of Outflow of Cash = The Present Value of Inflow of Cash

so,

2000 =600/(1.0y) + 600/ (1.0y)^2 + 1000/(1.0y)^3

Or we say, y= 4.498%

Therefore the IRR is 4.498%