4. (a) What is “internal rate of return” (IRR). Find the IRR of Projects M and P.

(Show your workings clearly by employing the trial-and-error method)

(b) According to IRR, which project or projects should be selected if they are

independent? What if they are mutually exclusive? Justify your answers by

stating the rationale of IRR.

(c) Would the IRR change if the required rate of return changed? Please explain.(Give an example)

 

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You are just appointed as the Financial Manager for Monster Resort Corporation. On your first duty reporting day, your boss has given you two proposed investment projects with the following estimated cash flows. Expected Net Cash Flow Year Project M Project P 0 ($100 000) ($100 000) 1 $10 000 $70 000 2 $60 000 $50 000 3 $80 000 $20 000 Project M involves constructing a new resort in a new market, it would take some time to build up the clientele, and so the cash inflows would increase over time. Project P involves renovating of an old resort in an economically saturated market, and its cash flows would decrease over time. Both projects have 3-year project lives. Depreciation, trade-in values, net working capital requirements, and tax effects are all included in these cash flows. Both projects have risk characteristics which are similar to the company's average project. Monster Resort Corporation requires a rate of return of 10% per year. You are now instructed to determine whether one or both of these two investment projects should be selected. And you decided to apply three common capital budgeting techniques for evaluation. You are just appointed as the Financial Manager for Monster Resort Corporation. On your first duty reporting day, your boss has given you two proposed investment projects with the following estimated cash flows. Expected Net Cash Flow Year Project M Project P 0 ($100 000) ($100 000) 1 $10 000 $70 000 2 $60 000 $50 000 3 $80 000 $20 000 Project M involves constructing a new resort in a new market, it would take some time to build up the clientele, and so the cash inflows would increase over time. Project P involves renovating of an old resort in an economically saturated market, and its cash flows would decrease over time. Both projects have 3-year project lives. Depreciation, trade-in values, net working capital requirements, and tax effects are all included in these cash flows. Both projects have risk characteristics which are similar to the company's average project. Monster Resort Corporation requires a rate of return of 10% per year. You are now instructed to determine whether one or both of these two investment projects should be selected. And you decided to apply three common capital budgeting techniques for evaluation.