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Homework answers / question archive / You are deciding between two mutually exclusive investment opportunities
You are deciding between two mutually exclusive investment opportunities. Both require the same initial investment of $9.9 million. Investment A will generate $1.83 million per year (starting at the end of the first year) in perpetuity. Investment B will generate $1.45 million at the end of the first year, and its revenues will grow at 2.1% per year for every year after that. a. Which investment has the higher IRR? b. Which investment has the higher NPV when the cost of capital is 7.8%? c. In this case, when does picking the higher IRR give the correct answer as to which investment is the best opportunity? a. Which investment has the higher IRR? The IRR of investment Ais 18.48 %. (Round to two decimal places.) The IRR of investment B is 16.75%. (Round to two decimal places.) Based on the IRR, you would pick investment A (Select from the drop-down menu.) b. Which investment has the higher NPV when the cost of capital is 7.8%? If the cost of capital is 7.8%, the NPV of investment A is $ million. (Round to two decimal places.)
C. The IRR rule will work better when the discount rate or the cost of capital is not known and may vary over the life of the project. In that case, we select the project with higher IRR because we may not know, what will be the opportunity cost of capital, so it is desired that IRR is higher.
When cost if capital is known, NPV rule should be used to evaluate the project.
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