Question

A firm utilizes a strategy of capital rationing, which is currently $375,000 and is considering the following two projects: Project A has a cost of $335,000 and the following cash flows: year 1 $140,000; year 2 $150,000; and year 3 $100,000. Project B has a cost of $365,000 and the following cash flows: year 1 $220,000; year 2 $110,000; and year 3 $150,000. Using a 6% cost of capital, what is the internal rate of return of project B?

Answer 1

IRR is the Rate at which PV of Cash Inflows are equal to PV of Cash Outflows

Year	CF	PVF @16%	Disc CF	PVF @17%	Disc CF
0	$ -3,65,000.00	1.0000	$ -3,65,000.00	1.0000	$ -3,65,000.00
1	$ 2,20,000.00	0.8621	$ 1,89,655.17	0.8547	$ 1,88,034.19
2	$ 1,10,000.00	0.7432	$      81,747.92	0.7305	$      80,356.49
3	$ 1,50,000.00	0.6407	$      96,098.65	0.6244	$      93,655.58
NPV			$        2,501.74		$      -2,953.74

IRR = Rate at which least +Ve NPV + [ NPV at that Rate / Change IN NPV due to 1% inc in Disc Rate ] * 1%

= 16% + [ 2501.74 / 5455.48 ] * 1%

= 16% + 0.46%

= 16.46%