Case (5): NPV & IRR of Projects: PE1, PE2 and PE3

The Directors of the industrial company CUCO have received three mutually exclusive
investment proposals coded PE1, PE2, and PE3. The economic life of each one is 7
years starting from 2020 to 2026 including 2 years of establishment. Only one of
these three alternative investment proposals should preliminary be nominated for
acceptance.

The following are the Net Cash Flows (NCFs) of PE1, PE2 and PE3 in L.E million:
Years Y-2 Y-1 Y1 Y2 Y3 Y4 Y5
PE1 (24) (24) 17.12 16.34 15.56 14.78 14.302
PE2 (16) (16) 12.12 11.34 10.56 9.78 7.3915
PE3 (26.0988) (24) 18.32 17.54 16.76 15.98 15.502

The discount rate of the company is currently 15%. The Internal Rate of Return (IRR)
for each of PE1 and PE2 is 16%, while the IRR for PE3 is more than 16%.

Required:
a. Use the NPV method to rank PE1, PE2 and PE3.
b. Find out the IRR of PE3.

For guidance, the PV of L.E 1, i.e. 1/(𝟏 + 𝒓)𝒏 :

Years 1 2 3 4 5 6 7
15% 0.8696 0.7561 0.6575 0.5718 0.4972 0.4323 0.3759
16% 0.8621 0.7432 0.6407 0.5523 0.4761 0.4104 0.3538
17% 0.8547 0.7305 0.6244 0.5337 0.4561 0.3898 0.3332
18% 0.8475 0.7182 0.6086 0.5158 0.4371 0.3704 0.3139

Round-up the NPV to the nearest L.E 1, then ignore any positive or negative NPV of
less than L.E 50.
 Sol.
a. Ranking by using the NPV method by applying the given current discount rate 15%:

PV of L.E PE1 PE2 PE3

1 at the
Year given
NCF PV of NCF NCF PV of NCF NCF PV of NCF
disc. rate
15%
Y-2 (2020) 0.8696 (24) (20.870 4) (16) (13.913 6) (26.098 8) (22.695 516)
Y-1 (2021) 0.7561 (24) (18.146 4) (16) (12.097 6) (24) (18.146 4)
Y1 (2022) 0.6575 17.12 11.256 4 12.12 7.968 8 18.32 12.045 4
Y2 (2023) 0.5718 16.34 9.343 212 11.34 6.484 212 17.54 10.029 372
Y3 (2024) 0.4972 15.56 7.736 432 10.56 5.250 432 16.76 8.333 072
Y4 (2025) 0.4323 14.78 6.389 394 9.78 4.227 894 15.98 6.908 154
Y5 (2026) 0.3759 14.302 5.376 121 8 7.3915 2.778 464 8 15.502 5.827 201 8
1.084759 8 0.698702 8 2.301283 8
NPV
≈ 1.084760 ≈ 0.698703 ≈ 2.301284
Ranking Second Third First

PE3 is to be nominated for acceptance according to the NPV method.

b. Finding- out the IRR of PE3: By trying discount rate 17%:

PV of L.E 1
Year NCF PV of NCF
at rate 17%
Y-2 (2020) 0.8547 (26.098 8) (22.306 644)
Y-1 (2021) 0.7305 (24) (17.532)
Y1 (2022) 0.6244 18.32 11.439 008
Y2 (2023) 0.5337 17.54 9.361 098
Y3 (2024) 0.4561 16.76 7.644 236
Y4 (2025) 0.3898 15.98 6.229 004
Y5 (2026) 0.3332 15.502 5.165 266 4
NPV - 0.0000316
≈ 0.000032 ≈ Zero
The IRR of PE3 is 17%.

PE3 is to be nominated for acceptance according to the IRR method.