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and verified and be clear.

The net present value (NPV) and internal rate of return (IRR) methods of investment analysis are interrelated and are sometimes used together to make capital budgeting decisions. Consider the case of Blue Hamster Manufacturing Inc.: Last Tuesday, Blue Hamster Manufacturing Inc. lost a portion of its planning and financial data when both its main and its backup servers crashed. The company's CFO remembers that the internal rate of return (IRR) of Project Lambda is 13.8%, but he can't recall how much Blue Hamster originally invested in the project nor the project's net present value (NPV). However, he found a note that detailed the annual net cash flows expected to be generated by Project Lambda. They are: Year Year 1 Year 2 Year 3 Year 4 Cash Flow $2,000,000 $3,750,000 $3,750,000 $3,750,000 The CFO has asked you to compute Project Lambda's initial investment using the information currently available to you. He has offered the following suggestions and observations: A project's IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows equals the discounted value of its cash outflows-when the cash flows are discounted using the project's IRR. The level of risk exhibited by Project Lambda is the same as that exhibited by the company's average project, which means that Project Lambda's net cash flows can be discounted using Blue Hamster's 9% WACC. , and its NPV is Given the data and hints, Project Lambda's initial investment is (rounded to the nearest whole dollar). A project's IRR will if the project's cash inflows decrease, and everything else is unaffected. If projects are mutually exclusive, only one project can be chosen. The internal rate of return (IRR) and the net present value (NPV) methods will not always choose the same project. If the crossover rate on the NPV profile is below the horizontal axis, the methods will always agree. Projects Y and Z are mutually exclusive projects. Their cash flows and NPV profiles are shown as follows. NPV (Dollars) 800 Year Project Y Project Z 0 -$1,500 -$1,500 1 $200 $900 $400 $600 $600 $300 $1,000 $200 Project Y Project 2 200 If the weighted average cost of capital (WACC) for each project is 10%, do the NPV and IRR methods agree or conflict? -200 0 2 4 6 8 The methods conflict. The methods agree. 10 12 14 16 18 20 COST OF CAPITAL (Percent) A key to resolving this conflict is the assumed reinvestment rate. The IRR calculation assumes that intermediate cash flows are reinvested at the internal rate of return (IRR) and the NPV calculation implicitly assumes that the rate at which cash flows can be reinvested is the required rate of return As a result, when evaluating mutually exclusive projects, the NPV method is usually the better decision criterion