Garage, Inc., has identified the following two mutually exclusive projects: YearCash Flow (A)Cash Flow (B)0-$43,500-$43,500121,4006,400218,50014,700313,80022,80047,60025,200 What is the IRR for each of these projects? Using the IRR decision rule, which project should the company accept? Is this decision necessarily correct?If the required return is 11 percent, what is the NPV for each of these projects? Which project will the company choose if it applies the NPV decision rule?Over what range of discount rates would the company choose project? A? Project B? At what discount rate would the company be indifferent between these two projects? Explain.

Question
Asked Apr 5, 2019
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Garage, Inc., has identified the following two mutually exclusive projects:

 

Year

Cash Flow (A)

Cash Flow (B)

0

-$43,500

-$43,500

1

21,400

6,400

2

18,500

14,700

3

13,800

22,800

4

7,600

25,200

 

  1. What is the IRR for each of these projects? Using the IRR decision rule, which project should the company accept? Is this decision necessarily correct?
  2. If the required return is 11 percent, what is the NPV for each of these projects? Which project will the company choose if it applies the NPV decision rule?
  3. Over what range of discount rates would the company choose project? A? Project B? At what discount rate would the company be indifferent between these two projects? Explain.

 

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Expert Answer

Step 1

Note:

We shall answer the first question since the exact one wasn’t specified. Please submit a new question specifying the one you’d like to get answered.

Step 2

Internal rate of return (IRR) is the discount rate at which present value of cash inflow is equal to the cash outflow. For calculating the value of IRR of projects A and B, first we are calculating present value of cash inflow of both projects at two different discounting rate.

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Step 3

Calculating the internal rate of return of project A. We have,

IRR = r – [( PVCO – PVCI ) / (PV10% - PV20%)] X Difference in discounting rate

Here,

r = 20%

PVCO = Present value of cash outflow = $ 43,500

PVCI = Present value of cash inflow at 20% = $ 42,332

PV10% = $ 50,303

PV20% = $ 42,332

By substituting these value in the above formul...

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