Alright class, today we're going to explore an illustration of NPV (Net Present Value) versus IRR (Internal Rate of Return) for two investment projects undertaken by the National Fertilizer Company. We will analyze the cash flows for each project and interpret the provided results.
### Project A
1. Initial Investment (Year 0): Rs. -10,000
2. Cash Flow in Year 1: Rs. 2,000
3. Cash Flow in Year 2: Rs. 4,000
4. Cash Flow in Year 3: Rs. 12,000
### Project B
1. Initial Investment (Year 0): Rs. -10,000
2. Cash Flow in Year 1: Rs. 10,000
3. Cash Flow in Year 2: Rs. 3,000
4. Cash Flow in Year 3: Rs. 3,000
### Provided Results
From our data, we already have the computed values for the Net Present Value at a 10% discount rate as well as the Internal Rate of Return for both projects. Let's examine these results.
#### NPV at 10%
- NPV for Project A: Rs. 4,140
- NPV for Project B: Rs. 3,824
#### IRR (Internal Rate of Return)
- IRR for Project A: 26.55%
- IRR for Project B: 37.63%
### Interpretation
Net Present Value (NPV):
Net Present Value is the sum of the present values of the incoming and outgoing cash flows over a period of time. It helps us understand the profitability of a project by illustrating the difference between the project's value and its cost in terms of present value.
- NPV of Project A (4,140): This positive NPV indicates that Project A is expected to generate a net inflow of Rs. 4,140 over its cost when discounted at a rate of 10%.
- NPV of Project B (3,824): Similarly, the NPV for Project B is positive, meaning Project B is expected to generate Rs. 3,824 over its cost when discounted at the same rate.
Internal Rate of Return (IRR):
IRR is the discount rate that makes the NPV of all cash flows from a particular project equal to zero. It is an indicator of the efficiency or quality of an investment.
- IRR of Project A (26.55%): This percentage tells us that at a 26.55% discount rate, the project's net present value would be zero. It’s a measure of the projected yield of the project.
- IRR of Project B (37.63%): Higher than Project A, this IRR indicates that Project B's projected yield is higher and achieves a break-even point at a discount rate of 37.63%.
### Decision Making
- Choosing Projects Based on NPV: If you're looking to maximize absolute value, you may lean towards Project A since its NPV (4,140) is higher than that of Project B (3,824).
- Choosing Projects Based on IRR: If your investment decision criteria is based on yield percentage, you might prefer Project B with its higher IRR of 37.63% compared to Project A's 26.55%.
In conclusion, both Project A and Project B are profitable according to their NPVs and IRRs. However, the ultimate decision on which project to take on may depend on your specific investment criteria – whether you prioritize higher absolute returns (NPV) or higher yield percentages (IRR).
