Question

Anderson International Limited is evaluating a project in Erewhon. The project will create the following cash flows:

  

Year	Cash Flow
0	–$	1,180,000
1		355,000
2		420,000
3		315,000
4		270,000

  

All cash flows will occur in Erewhon and are expressed in dollars. In an attempt to improve its economy, the Erewhonian government has declared that all cash flows created by a foreign company are “blocked” and must be reinvested with the government for one year. The reinvestment rate for these funds is 4 percent.

  

If Anderson uses a required return of 8 percent on this project, what are the NPV and IRR of the project?

Answer 1

In the current question cash flows are blocked with the government for one year,so cash flows will come after 1 year of actual earning

NET PRESENT VALUE means the difference between the Present value of all cash outflows and present values of all inflows and it will be discounted at the required rate of the anderson i.e 8%

Year	Cashflows	Discounting factor @8%	Present value	Actual cash flows	cash flows which can be repatriated
0	-1180000	1	-1180000	0	0
1	0	0.943396226	0	355000	0
2	369200	0.88999644	328586.6857	420000	369200
3	436800	0.839619283	366745.7028	315000	436800
4	327600	0.792093663	259489.8841	270000	327600
5	280800	0.747258173	209830.0949	0	280800
			-15347.6325

As cash flows are blocked for one year,so it is added to next year with interest of 4%

Formula for amount which can be repatriated is Actual amount(1+r)^n

where r = rate of interest (presently interest is 4% so r = 0.04

n = number of years to be invested

As NPV is negative it is not feasiable to invest in that country

IRR means discount rate at which Present value of cash outflows will be equal to cash inflows

this IRR will be found out using trial and error method by taking to different discounting rates and comparing them to find out at which rate NPV will be ZERO.

Year	Cashflows	Discounting factor @5%	Present value	Discounting factor @6%	Present value
0	-1180000	1	-1180000	1	-1180000
1	0	0.952380952	0	0.943396226	0
2	369200	0.907029478	334875.2834	0.88999644	328586.6857
3	436800	0.863837599	377324.263	0.839619283	366745.7028
4	327600	0.822702475	269517.3307	0.792093663	259489.8841
5	280800	0.783526166	220014.1475	0.747258173	209830.0949
			21731.02477		-15347.6325

So @ discount rate 5% NPV is positive and @ discount rate 6% is negative so IRR will in between 5 & 6

for clear understanding IRR = 5.586 (APPROX)

IRR = 5 + ((21731.02477-0)/(21731.02477-(-15347.6325))*(6-5)    { THIS 6 & 5 are discount rates

= 5+21731.02477/(21731.025+15347.63)

=5+21731.02477/37078.655

=5+0.586

=5.586