Prestwood Products Company's cost of capital is 11.2% and the company is considering two mutually exclusive projects. In the past, it usually takes about 5 years for the company to recoup its investments from a good project. The projects' expected cash flows are as follows: Project B's IRR is?
Prestwood Products Company's cost of capital is 11.2% and the company is considering two mutually exclusive projects. In the past, it usually takes about 5 years for the company to recoup its investments from a good project. The projects' expected cash flows are as follows: Project B's IRR is?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Question
Prestwood Products Company's cost of capital is 11.2% and the company is considering two mutually exclusive projects. In the past, it usually takes about 5 years for the company to recoup its investments from a good project. The projects' expected cash flows are as follows:
Project B's IRR is?
Transcribed Image Text:The table compares the cash flows for Project A and Project B over a period of 8 years. Each entry represents the cash flow in dollars for that particular year and project.
### Table Breakdown:
- **Year 0**:
- **Project A**: Cash outflow of $(300).
- **Project B**: Cash outflow of $(405).
- **Year 1**:
- **Project A**: Cash outflow of $(387).
- **Project B**: Cash inflow of $134.
- **Year 2**:
- **Project A**: Cash outflow of $(193).
- **Project B**: Cash inflow of $134.
- **Year 3**:
- **Project A**: Cash inflow of $100.
- **Project B**: Cash inflow of $234.
- **Year 4**:
- **Project A**: Cash inflow of $600.
- **Project B**: Cash inflow of $134.
- **Year 5**:
- **Project A**: Cash inflow of $600.
- **Project B**: Cash inflow of $134.
- **Year 6**:
- **Project A**: Cash inflow of $650.
- **Project B**: Cash inflow of $134.
- **Year 7**:
- **Project A**: Cash inflow of $50.
- **Project B**: No cash flow ($0).
### Analysis Summary:
- **Project A** initially has negative cash flows (outflows) in the first three years and then shifts to positive cash flows (inflows) from Year 3 onwards, with the highest inflow of $650 in Year 6.
- **Project B** starts with a higher negative cash flow in Year 0 but maintains consistent inflows from Year 1 through Year 6, with a single higher inflow in Year 3, and no inflow in Year 7.
Expert Solution
Step 1
Internal Rate of Return (IRR): It is a tool used in capital budgeting decisions for evaluating an investment's profitability. If the project's cost of capital is more than IRR then it is not preferable for the company to invest in the project. It is preferable to take projects that is having an IRR more than the cost of capital.
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