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NPV's and IRRs for Mutually Exclusive Projects

Davis Industries must choose between a gas-powered and an electric -powered fork-lift truck for moving materials in its factory. Since both forklifts perform the same function, the firmwill choose only one.

The electric truck will cost more but cost less to operate. Cost is $22,00 for the electric and the gas powered is $17,500. The cost of capital that applies to both is 12%. The life of both is 6 years, the net cash flows for the electric powered truck will be $6,290 per year and those for the gas-powered truck will be $5,000 per year. Annual net cash flows include depreciation expenses.

Calculate the NPV and the IRR for each type of truck, and decide which to recommend.

Solution Preview

The IRR is the discount rate that makes the NPV of an investment zero. An investment should be accepted if it is higher than the required return; if it is lower, the project is not acceptable. Here the IRR is 20% which is higher than the cost of capital of 20%. Thus we will accept the project. The IRR can be a problem if cash flows are not conventional or when in this case with multiple projects to compare, the IRR can be misleading and not provide the actual best investment. IRR is a discount rate: the rate at which the present value of a series of investments is equal to the present value of the returns on those investments. As such, it can be found not only for equal, periodic investments such as those considered here but for any series of investments and returns. For example, if you have made a number of irregular purchases and sales of a particular stock, the IRR on your transactions ...

Solution Summary

NPV's and IRRs for Mutually Exclusive Projects are investigated.

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