The situation
A machine shop has one installation window before orders pick up. Its operations manager likes the cheaper upgrade because the supplier advertises the higher percentage return.
The finance team wants to know which option adds more money at the company’s required return. The workshop can install only one upgrade.
- Upgrade A: pay → receive
- ₹1 lakh → ₹1.4 lakh
- Upgrade B: pay → receive
- ₹5 lakh → ₹6.5 lakh
- Required return
- 10%
Full data and assumptions
A costs ₹1 lakh and returns ₹1.4 lakh in a year. B costs ₹5 lakh and returns ₹6.5 lakh in a year. The business can do either project and uses a 10% hurdle.
Your task
Which has the higher IRR and which adds more value?
Reveal step-by-step solution
Set up the problem
For one year, divide proceeds by cost and subtract one. IRR is 40% for A and 30% for B.
Work through the numbers
A adds ₹1.4 ÷ 1.10 − ₹1 ≈ ₹0.27 lakh. B adds ₹6.5 ÷ 1.10 − ₹5 ≈ ₹0.91 lakh.
Interpret the result
Choose B if both are feasible and the 10% rate fits both risks. It adds more rupees even though A earns the higher percentage.
What to remember
Use NPV to rank mutually exclusive projects at an appropriate hurdle.