In: Accounting
A project has an initial cost of $160,000 and an estimated
salvage value after 15 years of $75,000. Estimated average annual
receipts are $30,000. Estimated average annual disbursements are
$16,000. Assuming that annual receipts and distributions will be
uniform for the 15 years, compute the prospective rate of return
before taxes.
Project IRR is given by - | ||||
Present value of Cash Outflow= Present Value of Cash Inflow | ||||
An approximation of IRR is made on the basis of Cash Flow data. A rough approximation made with reference to the payback period. | ||||
I. | Present Value of Cash Outflow | |||
Initial Investment | $160,000 | |||
II | Present Value of Cash Inflow at 6% | |||
Average Annual Receipt | $30,000 | |||
Less: Average Annual Disbursement | $16,000 | |||
Net Receipt | $14,000 | |||
Annuity factor | 9.712 | $135,968 | ||
Salvage Value at the end of 15 years | $75,000 | |||
PV factor | 0.417 | $31,275 | $167,243 | |
Present Value of Cash Inflow at 7% | ||||
Average Annual Receipt | $30,000 | |||
Less: Average Annual Disbursement | $16,000 | |||
Net Receipt | $14,000 | |||
Annuity factor | 9.108 | $127,512 | ||
Salvage Value at the end of 15 years | $75,000 | |||
PV factor | 0.362 | $27,150 | $154,662 | |
The exact IRR by interpolating between 6% and 7% is work out as follows | ||||
IRR = 6% + | $167,243-$160,000 | X1% | ||
$167,243-$154,662 | ||||
IRR = 6% + | $7,243 | X1% | ||
$12,581 | ||||
=6.58% | ||||
Therefore, the IRR of the Project is 6.58% |