Question

A project provides annual cash flows of £800 per year for 8 years and costs £3000 today. Is this a good project if the required return is 8%?

At what discount rate would you be indifferent between accepting the project and rejecting it?

Answer 1

Hi

Here cash flows = -3000, 800,800,800, 800, 800, 800, 800, 800

rate of return r = 8%

We will find out Net present value of these case flows

Net Present Value = -3000 + 800/(1+8%) + 800/(1+8%)^2+.............800/(1+8%)^3

Net present Value = -3000 + 740.74 + 685.87 +635.06 + 588.02 + 544.46 + 504.13+466.79 +432.21

= $1,597.31

Since net present value is positive, hence this is a good project to invest.

for finding out the discount rate where you would be indifferent between accepting and rejecting, we will find the Internal Rate of Return for the cash flows.

For finding out IRR, we will use excel IRR function.

Below is excel IRR formulas and values below:

Values:

	Time	Cash Flows
	0	-3000
	1	800
	2	800
	3	800
	4	800
	5	800
	6	800
	7	800
	8	800
	IRR	20.8%

Hence at 20.8% discount rate, we will be indifferent between accepting and rejecting the project.

Thanks