Question

(Ignore income taxes in this problem.) Overland Corporation has gathered the following data on a proposed investment project:

Click here to view Exhibit 8B-1 and Exhibit 8B-2 to determine the appropriate discount factor(s) using tables.

Investment required in equipment	$	410,000
Annual cash inflows	$	60,000
Salvage value of equipment	$	0
Life of the investment		16	years
Discount rate		9	%

The company uses straight-line depreciation on all equipment. Assume cash flows occur uniformly throughout a year except for the initial investment.

The internal rate of return on the investment is closest to:    

8%

10%

12%

14%

Answer 1

Option 3 - 12% is Correct.

IRR Factor = Initial Investment / Annual Cash flow

IRR Factor = 410000 / 60000 = 6.833

locate this discount factor in “present value of an annuity of $1 in arrears table“. Since the useful life of the Equipment is 16 years, the factor would be found in 16-period line or row, for 6.833, nearby rate found as 12 % and 13 %, as per interpolating method, calculate NPV as per 12 % & 13%

Rate	Factor	Annual Cash flow	Discounted Cash flow	Initial Investment	NPV
12%	6.974	60,000	418,440	410,000	8,440
13%	6.604	60,000	396,240	410,000	(13,760)

IRR = (NPV OF LOWER RATE / DIFF . OF DISCOUNTED CASH FLOW WITH LOWER RATE & HIGHER RATE) + LOWER RATE

= (8440 / 22200) = 0.380 +12 = 12.380% = 12% (Rounded off)