Posted: January 26th, 2016
s. Why is the IRR decision rule unreliable inmaking the correct choice between the two projects?
Table 1. Synthetic Resin Cash Flows
|
Synthetic Resin |
||||||
|
Year |
0 |
1 |
2 |
3 |
4 |
5 |
|
Net Income |
$150,000 |
$200,000 |
$300,000 |
$450,000 |
$500,000 |
|
|
Depreciation |
$200,000 |
$200,000 |
$200,000 |
$200,000 |
$200,000 |
|
|
Net Cash Flow |
$(1,000,000) |
$350,000 |
$400,000 |
$500,000 |
$650,000 |
$700,000 |
Table 2. Epoxy Resin Cash Flows
|
Epoxy Resin |
||||||
|
Year |
0 |
1 |
2 |
3 |
4 |
5 |
|
Net Income |
$440,000 |
$240,000 |
$140,000 |
$ 40,000 |
$ 40,000 |
|
|
Depreciation |
$160,000 |
$160,000 |
$160,000 |
$160,000 |
$160,000 |
|
|
Net Cash Flow |
$(800,000) |
$600,000 |
$400,000 |
$300,000 |
$200,000 |
|
calculate the IRR and NPV for each project. Tim wants to convince the Board that the IRR measure can be misleading when choosing between mutually exclusive alternatives. Why is the IRR decision rule unreliable inmaking the correct choice between the two projects? Tim’s presentationshould inform the board on the different reinvestment assumptions underlying IRR and NPV and how that relates to the reliability of the IRR decision rule. What is the correct reinvestment assumption and why?
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