Question

A firm is considering a project that has an original outlay of $34,000 and will run for three years with cash flows of $15,000, $17,000 and $13,000 respectively. At a required return of 11%, should the firm accept the project? What if the required return is 24%? What is the project’s IRR?

Answer 1

Calculation of NPV :

Cash Outflows = 34,000

Calculation of Cash inflows:

Cash flows (1)	Discount rate @11% (2)	Discounted cash inflows (3) (1*2)
15,000	1/1.11=0.9009	13,513
17,000	1/(1.11)^2=0.8116	13,797
13,000	1/(1.11)^3=0.7312	9505
	Cash inflows	36,815

NPV = Cash inflows - Cash Outflows

= 36,815-34,000

= 2815

Since NPV is positive we can accept the project.

Calculation of NPV @24%

Cash flows (1)	Discount rate @24% (2)	Discounted cash inflows (3) (1*2)
15,000	1/1.24=0.8064	12,096
17,000	1/(1.24)^2=0.6504	11,057
13,000	1/(1.24)^3=0.5245	6818
	Cash inflows	29,971

NPV = Cash inflows - Cash outflows

= 29,971-34,000

= -4029

Since NPV is negative we should not accept the project

Calculation of IRR:

Calculation of Cash flows @12%:

Cash flows (1)	Discount rate @12% (2)	Discounted cash flows (3) (1*2)
15,000	1/1.12=0.8928	13,392
17,000	1/(1.12)^2=0.7972	13,552
13,000	1/(1.12)^3=0.7118	9253
	Cash inflows	36,197

Cash inflows @12% = 36,197

Cash inflows @11%= 36,815

By theory of interpolation

IRR = 11%+(36,815-34,000)/(36,815-36,197)*(12%-11%)

= 11%+2815/618*1%

= 11%+4.5%

= 15.5%

IRR = 15.5% (approximately)