How to Calculate Net Present Value and Internal Rate of Return for Mutually Exclusive Projects Consider two pollution prevention designs: Design A and Design B. Both designs have a project life of 5 years. Design A requires an initial outlay of $180,000 and has a net annual after-tax cash inflow of

Question

How to Calculate Net Present Value and Internal Rate of Return for Mutually Exclusive Projects

Consider two pollution prevention designs: Design A and Design B. Both designs have a project life of 5 years. Design A requires an initial outlay of $180,000 and has a net annual after-tax cash inflow of $60,000 (revenues of $180,000 minus cash expenses of $120,000). Design B, with an initial outlay of $210,000, has a net annual cash inflow of $70,000 ($240,000 − $170,000). The after-tax cash flows are summarized as follows:

CASH FLOW PATTERN

Design B	Design A	Year
$(210,000)	$(180,000)	0
70,000	60,000	1
70,000	60,000	2
70,000	60,000	3
70,000	60,000	4
70,000	60,000	5

The cost of capital for the company is 12%.

Required:

Calculate the NPV and the IRR for each project.

Accepted Answer

DESIGN A: NPV ANALYSIS

Year	Cash Flow	Discount Factor*	Present Value
0	$(180,000)	1	$(180,000)
1_5	60,000	3.60478	216,287
Net present value			$36,287

DESIGN A: IRR ANALYSIS
Discount Factor = Initial Investment/Annual Cash Flow
= $180,000/$60,000
= 3.00000
From Exhibit 12B.2 (p. 671), df = 3.00000 for 5 years implies that IRR ≈ 20%.
DESIGN B: NPV ANALYSIS

Year	Cash Flow	Discount Factor*	Present Value
0	$(210,000)	1	$(210,000)
1_5	70,000	3.60478	252,335
Net present value			$42,335

DESIGN B: IRR ANALYSIS
Discount Factor = Initial Investment/Annual Cash Flow
= $210,000/$70,000
= 3.00000
From Exhibit 12B.2, df =3.00000 for 5 years implies that IRR ≈ 20%.
*From Exhibit 12B.2.

Question 12.5: How to Calculate Net Present Value and Internal Rate of Retu...

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