Question

A computer call center is going to replace all of its incandescent lamps with more energy efficient fluorescent lighting fixtures. The total energy savings are estimated to be $1,875 per year, and the cost of purchasing and installing the fluorescent fixtures is $4,900. The study period is five years, and terminal values for the fixtures are negligible. What is the IRR of this investment? Express your answer in percent rounded to two decimal places.

STEP BY STEP SOLUTION PLS NO (P/A, %)

Answer 1

Answer)

Calculation of Internal rate of return

Internal rate of return is the rate at which the present value of cash inflows is equal to the present value of cash outflows. Thus it is the rate at which the net present value of a project is Zero. Internal rate of return can be calculated by computing the approximate present value annuity factor.

Approximate Present value annuity factor = Initial investment in the project/ Annual incremental cash inflow on account of savings in operating costs

                                                                              = $ 4,900/ $ 1,875

                                                                              = 2.61333

The present value of annuity of $ 1 in 5 years row at 26% rate is 2.63507 and 27% rate is 2.58267. Since the present value annuity factor for 5 years is 2.61333, the Internal rate of return lies between 26% and 27%. The same can be calculated by interpolating between these two rates.

Internal rate of return = 26% + (2.63507 – 2.61333)/ (2.63507 – 2.58267)

                                         = 26% + 0.02174/0.0524

                                         = 26.41%

Thus the internal rate of return of the investment is 26.41%.