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.

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%

ekkarill92 answered 6 months ago

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