3. Understanding the IRR and NPV The net present value (NPV) and internal rate of return (TRR) methods of investment analysis are interrelated and are sometimes used together to make capital budgeting decisions Consider the case of Green Caterpillar Garden Supplies Inc.: Last Tuesday, Green Caterpillar Garden Supplies Inc. lost a portion of its planning and financial data when both its main and its backup servers crashed. The company's CFO remembers that the internal rate of return (IRR) of Project Delta is 13.8%, but he can't recall how much Green Caterpillar originally invested in the project nor the project's net present value (NPV). However, he found a note that detailed the annual het cash flows expected to be generated by Project Delta. They are: Year Cash Flow Year 1 $1,800,000 Year 2 Year 3 Year 4 $3,375,000 $3,375,000 $3,375,000 The CFO has asked you to compute Project Delta's initial investment using the information currently available to you. He has offered the following suggestions and observations: A project's IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows equals the discounted value of its cash outflows-when the cash flows are discounted using the project's IRR. The level of risk exhibited by Project Delta is the same as that exhibited by the company's average project, which means that Project Delta's net cash flows can be discounted using Green Caterpillar's 9% WACC. and its NPVIS (rounded to the nearest whole Given the data and hints, Project Delta's initial investment is dolar) A project's IRR will If the project's cash inflows increase, and everything else is unaffected. TOTU: Project Delta's initial investment using the information currently available to e return the project would cenerate when its NPV is zero or the discounted valu f its cash outflows-when $8,490,228 5 are discounted using the project's IRE Project Delta is the same $8.605,839 non led by the company's average project, discounted using Green WACC. $9,874,235 $8,849,868 elta's initial investment is , and its NPV is if the project's cash inflows increase, and everything else is unaffected. Grade it Now equals the discounted value of its cash outflows-when the cash flows are discounted usi $998,872 The level of risk exhibited by Project Delta is the same as that exhibited by the company1 e company $1,198,646 10 Delta's net cash flows can be discounted using Green Caterpillar's 9% WACC. $1,098,759 IRR. ect, which means that Project $849,041 , and its NPV is (rounded to the nearest w Given the data and hints, Project Delta's initial investment is dollar). decrease increase ta's initial investment is , and its NPV is (rout Given the data and dollar). stay the same A project's IRR will
