Question

An investment has an installed cost of $526,800. The cash flows over the four-year life of the investment are projected to be $222,850, $239,450, $206,110, and $154,820, respectively.

a.) If the discount rate is zero, what is the NPV?

b.) f the discount rate is infinite, what is the NPV?

c.) At what discount rate is the NPV just equal to zero?

Answer 1

a). At a zero discount rate (and only at a zero discount rate), the cash flows can be added together across time.

NPV = -$526,800 + $222,850 + $239,450 + $206,110 + $154,820

= $296,430

b). If the required return is infinite, future cash flows have no value. Even if the cash flow in one year is $1 trillion, atan infinite rate of interest, the value of this cash flow today is zero. So, if the future cash flows have no value today,the NPV of the project is simply the cash flow today, so at an infinite interest rate:

NPV = −$526,800

c). The interest rate that makes the NPV of a project equal to zero is the IRR.
To find the IRR, we need to put the following values in the financial calculator:

CF0 = -526,800; C01 = 222,850; F01 = 1; C02 = 239,450; F02 = 1; C03 = 206,110; F03 = 1; C04 = 154,820; F04 = 1;

Press IRR, then CPT, which gives us 22.01

So, IRR = 22.01%