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Comparing two alternatives based on IRR, NPV methods

Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporation (BRC). Both projects require an annual return of 15 percent.

Year Deepwater Fishing New Submarine Ride
0 -$600,000 -$1,800,000
1 270,000 1,000,000
2 350,000 700,000
3 300,000 900,000

As a financial analyst for BRC, you are asked the following questions:
a. If your decision rule is to accept the project with the greater IRR, which project should you choose?

b. Because you are fully aware of the IRR rule's scale problem, you calculate the incremental IRR for the cash flows. Based on your computation, which project should you choose?

c. To be prudent, you compute the NPV for both projects. Which project shoul you choose? Is it consistent with the incremental IRR rule?

Solution Preview

Please see the attached file.

a. If your decision rule is to accept the project with teh greater IRR, which project hould you choose?

Figures in dollars
Present Values at
Year Deep water Fishing 20% 24% 25%
0 -600,000 -600,000 -600,000 -600,000
1 270,000 225,000 217,742 216,000
2 350,000 243,056 227,627 224,000
3 300,000 173,611 157,346 153,600
Net PV 41666.86667 2715.825244 -6399.75

IRR =Approx. 24.29%

Figures in dollars
Present Values at
Year New ...

Solution Summary

Solution explains the steps in choosing one alternative from Deepwater fishing and New Submarine Ride based on IRR, Incremental IRR and NPV methods.

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