You are considering two independent projects. Project A has an initial cost of $125,000 and cash inflows of $46,000, $79,000, and $51,000 for Years 1 to 3, respectively. Project B costs $135,000 with expected cash inflows for Years 1 to 3 of $50,000, $30,000, and $100,000, respectively. The required return for both projects is 16 percent. Based on IRR, you should:
A) accept both projects.
B) accept Project A and reject Project B.
C) accept Project B and reject Project A.
D) reject both projects.
E) accept either one of the projects, but not both.

Question

Quizplus · Accepted Answer

To determine the IRR (internal rate of return) of each project, we need to calculate the present value of the cash inflows and compare it to the initial cost.

For Project A:

PV = 46,000/(1+0.16)^1 + 79,000/(1+0.16)^2 + 51,000/(1+0.16)^3 
PV = 37,260.51 + 56,698.23 + 32,135.57 
PV = 126,094.31

Since the present value of the cash inflows is greater than the initial cost of $125,000, Project A has an IRR greater than the required return of 16%, making it a good investment.

For Project B:

PV = 50,000/(1+0.16)^1 + 30,000/(1+0.16)^2 + 100,000/(1+0.16)^3 
PV = 43,103.45 + 21,994.63 + 69,129.68 
PV = 134,227.76

Since the present value of the cash inflows is less than the initial cost of $135,000, Project B has an IRR less than the required return of 16%, making it a bad investment.

Therefore, we should accept Project A and reject Project B.

You Are Considering Two Independent Projects