Forums Finance Capital Budgeting NPV IRR

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  • #15992

    Coca Cola corporation want to develop and market a new energy drink and must choose between 2 options. The rate of discount is 9%.
    Red pig caffeine Delight
    Year Cash flow Cash flow IRR
    1 250 140 23%
    2 300 179 36%

    a) Which energy drink should a company produce If we follow the NPV rule.
    b) Can we use the IRR rule to decide which drink to produce. If not then can we adapt the IRR rule to choose the best project? How?

    #15995

    Solution
    NPV for Red Pig
    Cash outflow = 400
    Cash inflow = 250/(1+.09)1 + 300/(1+.09)2
    = 229.35 + 252.50
    = 481.86
    NPV = + 481.86 - 400 = - 81.86

    NPV for Caffeine Delight
    NPV = Present Value of Net Cash inflow
    Cash outflow = 200
    Cash inflow = 140/(1+.09)1 + 179/(1+.09)2
    = 128.44 + 150.66
    = 279.10
    NPV = Present value of Net Cash inflow
    = 279.10 – 200 = 79.10

    As per the NPV method we should opted for the red pig new energy drink.
    IRR Calculations
    IRR denotes that NPV = 0
    IRR of red pig is 23%
    IRR of caffeine Delight is 36%

    As in this condition we use to calculate the modified IRR also called the incremental IRR.
    Incremental IRR is calculated only o the incremental cash flows. That is extra cash inflows and cash outflows on the margin that result from choosing one project over another.

    0 = Cash outflow + cash Inflow C1/(1+i)1 + cash Inflow C2/(1+i)2
    0 = (-) 200 + 110/(1+i)1 + 121/(1+i)2
    Modified IRR = 9.5%

    So, the modified incremental IRR is greater than the cost of capital for red pig energy drink. Coca cola corporation should use the red pig energy drink.

    • This reply was modified 5 years, 1 month ago by amandeep kathuria.
    • This reply was modified 5 years, 1 month ago by amandeep kathuria.
    • This reply was modified 5 years, 1 month ago by admin.
    • This reply was modified 5 years, 1 month ago by admin.
    • This reply was modified 5 years, 1 month ago by admin.
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