A company is examining two mutually exclusive projects. Project P requires an immediate investment of $225,000 and produces no profit until the fourth year. Then the expected annual profit is $120,000 for Years 4 to 7 inclusive. Project Q requires an investment of $225,000 now and is expected to generate an annual profit of $55,000 in Years 1 to 7. Neither project has any residual value after seven years.
a. Calculate the IRR of each project. On the basis of their IRRs, which project is preferred?
b. Which project should be selected if the firm’s cost of capital is 16%?
c. Which project should be selected if the firm’s cost of capital is 13%?