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Calculating NPVs and IRRs of given projects

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Suppose we have two mutually exclusive land development projects. The first is a office building which can be constructed for an initial outlay of $20 million and sold a year later for $24 million. The other use of the land is for a parking lot where an initial outlay of $10,000 will produce a cash inflow of $10,000 per year forever. The NPV of the building project is given by: NPVB = -$20,000,000 + [$24,000,000/(1 + i)] where i is the cost of capital. The NPV of the perpetuity producing parking project is given by the expression: NPVp = -$10,000 + ($10,000/i).

1. Calculate the NPVs of both projects at a 15% cost of capital.

2. Calculate the IRRs of both projects.

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Solution Summary

NPV and IRR are two important capital budgeting parameters and help us in selecting suitable project/s. Solution to the given problem explains the methodology to find the NPVs and IRRs of given projects and then it selects the better project.

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Let us calculate NPV for building project.
PV of cash inflow after one year=24,000,000/(1+15%)^1=20869565.22
NPV of buiding project=NPVB=-Initial outlay+PV of cash flows=-20000000+20869565.22=$869,565.22

Let us calculate NPV for parking lot project.

It is case of perpetuity.

Annual cash ...

Solution provided by:
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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