14.3
Consider the following two projects:
| Year 0 | Year 1 | Year 2 | Year 3 | |
| A | -40 | 20 | -10 | 40 |
| B | -100 | 60 | 0 | 70 |
The opportunity cost of capital for both projects is 10%.
3. Looking at the cashflows, can you tell whether there are
any problems with using IRR in this case? EXPLAIN. (2 pts.)
Just by looking at the cashflows, one can see that you can’t
just use IRR to decide between the two projects. For starters,
the projects have different initial outflows (the size disparity).
They also have different timing of cash flows (project A has
cashflows every year and B only has cashflows in years 1 and 3)—the
timing disparity. Finally, project A has a sign switch in its
cashflows (they go from positive to negative from year 1 to 2),
meaning that there is more than one IRR for project A, so we don’t
know if 16.6% is the correct figure to be using.