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Consider the following two mutually exclusive projects: Whichever project you choose, if any, you require a return

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Consider the following two mutually exclusive projects:


Whichever project you choose, if any, you require a return of 11 percent on your investment.

a. If you apply the payback criterion, which investment will you choose? Why?

b. If you apply the discounted payback criterion, which investment will you choose? Why?

c. If you apply the NPV criterion, which investment will you choose? Why?

d. If you apply the IRR criterion, which investment will you choose? Why?

e. If you apply the profitability index criterion, which investment will you choose? Why?

f. Based on your answers in parts (a) through (e), which project will you finally choose? Why?

Transcribed Image Text:

Year Cash Flow (A) Cash Flow (B) -$291,000 -$41,600 1 37,000 20,000 2 55,000 17,600 3 55,000 17,200 4 366,000 14,000

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Fundamentals Of Corporate Finance

Fundamentals Of Corporate Finance

ISBN: 9781265553609

13th Edition

Authors: Stephen Ross, Randolph Westerfield, Bradford Jordan

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The internal rate of return, or IRR, is a metric used to measure the profitability of an investment. It is the discount rate that makes the net present value of an investment equal to zero. To calculate the IRR, we need to know the investment\'s cash flows. These are the inflows and outflows of cash that will result from the investment. For example, an investment in a property might have cash outflows for the purchase price, closing costs, and any renovations, and cash inflows from rent and eventual sale of the property. The IRR is the discount rate at which the NPV of the investment is equal to zero. There are many ways to calculate IRR, from simple spreadsheet functions to more complex financial modeling software. It\'s worth noting that IRR can be a bit tricky when it comes to projects that don\'t have a consistent cash flow over time. These types of investments are known as \"irregular cash flow\" and the IRR might be misleading or not suitable to calculate. There are other metrics to evaluate these investments such as Modified Internal Rate of Return (MIRR) which is a variation of IRR and is used to get more accurate results.

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