The discounted payback for each project is also in the fifth year, but further along in the fifth year for Project a compared to the simple payback.
The net present value of Project a is $18,269. The net present value for Project B. is $18,690. The IRR for Project a is 18%, and the IRR for Project B. is 15%. (see Appendix B)
The cause of the ranking conflict would be that the cash flows for Project B. are weighted towards the fifth year, whereas the flows for Project a are spread more evenly throughout the project's life. The ability to re-invest the earlier flows from Project a allows that project to have a higher IRR despite having a lower NPV.
The project that should be selected is Project B. This project has the higher net present value, and that should be the criteria for determining between two mutually exclusive projects. It is reasonable to assume that because this project's flows all come in the fifth year that it is a riskier project (the IRR supports this contention), but if that is the case, the discount rate should be higher for that project. Using the same discount rate implies that the risk for each project's cash flows is equivalent.
Appendix a: Net Present Value Calculation
Units Sold
70,000
120,000
140,000
80,000
60,000
Price
Year
0
1
2
3
4
5
Cost
-7900000
Installation
-100000
Revenue
21
36
42
24
15600000
VC
-12600000
-21600000
-25200000
-14400000
-10800000
Fixed Costs
-200000
br />
-200000
-200000
-200000
-200000
WC
-100000
-2100000
-3600000
-4200000
-2400000
-1560000
WC End
13960000
Tax Benefit
537200
537200
537200
537200
537200
Cash Flows
-8100000
6637200
11137200
12937200
7537200
17537200
PV
-8100000
5771478
8421323
8506419
4309419
8719088
NPV
$27,627,727
Depreciation
1580000
1580000
1580000
1580000
1580000
Tax Benefit
537200
537200
537200
537200
537200
Discount
0.15
Appendix B
Project a
Year
0
1
2
3
4
5
Cash Flows
-100,000
32,000
32,000
32,000
32,000
32,000
PV
-100,000
28,829
25,972
23,398
21,079
18,990
NPV
18,269
IRR
18%
Project B
Cash Flows
-100,000
0
0
0
0
200000
PV
-100,000
0
0
0
0
118690.27
NPV
18,690
IRR
15%
d
