Question

You are considering an investment for which you require a 13.5 percent rate of return. The investment costs $58,900 and will produce cash inflows of $25,000 for 3 years. Should you accept this project based on its internal rate of return? Why or why not?

A. Yes; because the IRR is 13.13 percent
B. Yes; because the IRR is 13.65 percent
C. Yes; because the IRR is 13.67 percent
D. No; because the IRR is 13.13 percent
E. No; because the IRR is 13.65 percent

F. There is no IRR for the project

Answer 1

Answer)

Calculation of Internal rate of return

Internal rate of return is the rate at which the present value of cash inflows will be equal to the Initial cash outflow.

Initial investment = Annual cash inflows X Present value of annuity of $ 1 at Internal rate of return for 3 years

Present value of annuity of $ 1 at Internal rate of return for 3 years = Initial investment/ Annual cash inflows

                                                                                                              = $ 58,900/ $ 25,000

                                                                                                              = 2.356               

The present value of annuity factor against 3 years row corresponding to 13% rate is 2.36115 and to 14% rate is 2.32163. Therefore internal rate of return can be calculated by interpolating between these two rates.

Internal rate of return = 13% + [(2.36115 – 2.356)/ (2.36115 -2.32163)]

                                        = 13% + (0.00515/ 0.03952)

                                        = 13.13%

Therefore internal rate of return on investment is 13.13%.

Decision: Since the internal rate of return on investment (i.e. 13.13%) is less than the required rate of return (i.e. 13.5%), the project should not be accepted.

Final answer: (D) No; because the IRR is 13.13 percent.