Question

In: Accounting

A project has an initial cost of $160,000 and an estimated salvage value after 15 years...

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.

Solutions

Expert Solution

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%

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