A firm has three independent projects under consideration each with a

A firm has three independent projects under consideration each with a required rate of return of 10%/ The total projects budget is only $2,000. Project X has an initial investment of $2,000 and a single cash flow in year one of $2,360.

Project Y has an initial investment of $1,000 and a single cash flow in year one of $1,200. Project Z has an initial investment of $1,000 and a single cash flow in year one of $1,170. Calculate the IRR and NPV for each of these projects. If we assume that we cannot “repeat” these projects (i.e., we cannot do project Z twice) which project or combination of projects should the firm undertake? Why?

ANSWER

Project X has an NPV of $145.45 and an IRR of 18.00%.
Project Y has an NPV of $90.91 and an IRR of 20.00%.
Project Z has an NPV of $63.64 and an IRR of 17.00%.
On a stand alone basis, project X is the best based on NPV, but a combination of projects Y and Z provides the greatest total NPV = $154,44, and a weighted average IRR of 18.50%. This combination maximizes NPV subject to the budget constraint of $2,000.