Question

Yasser Ben Rashid must earn a minimum rate of return of 12% to be adequately compensated for the risk of the following investment:

Initial Investment $16,000

End of Year Income   

   1 $7,000

   2 $4,000

   3 $6,000

   4 $3,000

   5    $3,100

a. Estimate the IRR on this investment.

b. On the basis of your finding in part a, should Yasser make the proposed investment? Explain.

Answer 1

a. Following table shows the cashflows of the project

Year	0	1	2	3	4	5
Cashflow	-16000	7000	4000	6000	3000	3100

IRR is the rate of return for which the NPV of the project is Zero.

Method 1: IRR Calculation using Excel

We can calculate the IRR of the project using the IRR Function in Excel as shown below:

=IRR(B2:G2) = 15.950279%

IRR = 15.95% (Rounded to two decimal places)

Method-2: IRR Calculation using Ba ii plus

CF₀ = -16000

C01 = 7000, F01 = 1

C02 = 4000, F02 = 1

C03 = 6000, F03 = 1

C04 = 3000, F04 = 1

C05 = 3100, F05 = 1

IRR -> CPT [ press IRR in the calculator, after that press CPT]

IRR = 15.95027851%

Answer -> 15.95%

b. the minimum rate of return = 12%

As per the IRR Rule, if the IRR of a project is greater than the minimum required rate of return, then the project should be accepted.

Here, the IRR is 15.95% and the minimum required rate of return is 12%. IRR is greater than the minimum required rate of return. Hence, the project should be accepted.

Yaseer should make the proposed investment

Accept