NPV versus IRR Bumbles Bees, Inc., has identified the following two mu

QUESTION

NPV versus IRR Bumbles Bees, Inc., has identified the following two mutually exclusive projects:a. What is the 1RR for each of these projects? Using the IRR decision rule, which project should the company accept? Is this decision necessarily correct?b. if the required return is 11 percent, what is the NPV for each of these projects? Which project will the company choose if it applies the NPV decision rule?c. Over what range of discount rates would the company choose project A? Project B? At what discount rate would the company be indifferent between these two projects?Explain.
Calculation of Internal Rate of Return for Project A is as follows; Internal Rate of Return=> Initial Investment = Cash Flow for 1st Year/ (1+r) + Cash flow for 2nd Year/ (1+r) ^2 + Cash flow for 3rd Year/ (1+r) ^3 + Cash flow for 4th year/ (1+r) ^4 Internal Rate of return => $37000= $19000/ (1+r) + $14000/ (1+r) ^2 + $12000/ (1+r) ^3 + $9000/ (1+r) ^4 Internal Rate of Return for Project A => 20% Calculation of Internal Rate of Return for Project B is as follows; Internal Rate of Return=> Initial Investment = Cash Flow for 1st Year/ (1+r) + Cash flow for 2nd Year/ (1+r) ^2 + Cash flow for 3rd Year/ (1+r) ^3 + Cash flow for 4th year/ (1+r) ^4 Internal Rate of return => $37000= $6000/ (1+r) + $12500/ (1+r) ^2 + $19000/ (1+r) ^3 + $23000/ (1+r) ^4 Internal Rate of Return for Project B => 19% According to Internal rate of return rule we should accept Project A as its return is higher than Project B. No this decision might not be correct as internal rate of return provides an insight about how the projects are going to fare although in actuality it might stay far away from the IRR. b. Net Present Value of Project A= -Initial Investment + Cash Flow for 1st Year/ (1+r) + Cash flow for 2nd Year/ (1+r) ^2 + Cash flow for 3rd Year/ (1+r) ^3 + Cash flow for 4th year/ (1+r) ^4 Net Present Value of Project A= $-37000 +$ 19000/ (1.11) + $14000/ (1.11) ^2 + $12000/ (1.11) ^3 +$ 9000/ (1.11) ^4 Net Present Value of Project A= $ 6182.707 Net Present Value of Project B=¦

ial Investment + Cash Flow for 1st Year/ (1+r) + Cash flow for 2nd Year/ (1+r) ^2 + Cash flow for 3rd Year/ (1+r) ^3 + Cash flow for 4th year/ (1+r) ^4 Net Present Value of Project B= $ -37000 + $6000/ (1.11) + $12500/ (1.11) ^2 + $19000/ (1.11) ^3 + $23000/ (1.11) ^4 Net Present Value of Project B= $ 7594.134 According to Net Present Value rule Project B should be accepted. C. To know at what rates Projects A and B must be accepted, we must first find out the difference in cash flows over a period of 4 years. Cash flows in Year 0= $37000- $37000=$0 Cash flows in Year 1= $19000- $6000= $13000 Cash flows in Year 2= $14000- $12500= $1500 Cash flows in Year 3= $12000- $19000= $-7000 Cash flows in Year 4= $9000- $23000= $-14000 Note: (Figures are deducted by=> Project A- Project B) Rate of Return=> 0= = Cash Flow for 1st Year/ (1+r) + Cash flow for 2nd Year/ (1+r) ^2 + Cash flow for 3rd Year/ (1+r) ^3 + Cash flow for 4th year/ (1+r) ^4 Rate of Return=> 15.61% This means that any rate below 15.61% project B must be accepted while any rate above 15.61% project A must be accepted.

ANSWER:

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