Question

A firm evaluates all of its projects by applying the IRR rule. If the required return is 14 percent, should the firm accept the following project?

Year Cash Flow

0 -$30,000

1 16,000

2 20,000

3 15,000

Answer 1

	IRR is that discount rate for which NPV = 0. It has to be found out by trial and error, by varying the discount rate till 0 NPV is reached.
	The trial and error can be done as given in table below:
	YEAR	CASH FLOW	PVIF at 14%	PV at 14%	PVIF at 30%	PV at 30%	PVIF at 33%	PV at 33%	PVIF at 32%	PV at 32%
	0	$          -30,000	1.00000	$ -30,000	1	$ (30,000)	1	$      (30,000)	1	$        (30,000)
	1	$           16,000	0.87719	$              14,035	0.76923	$          12,308	0.75188	$        12,030	0.75758	$          12,121
	2	$           20,000	0.76947	$              15,389	0.59172	$          11,834	0.56532	$        11,306	0.57392	$          11,478
	3	$           15,000	0.67497	$              10,125	0.45517	$            6,827	0.42505	$          6,376	0.43479	$            6,522
	NPV			$                9,549		$ 970		$ (288)		$ 121
	It can be seen that the WACC of 14% gives positive NPV. Hence, to reduce the NPV, the discount rate has to be increased.
	Trials with 30%, 32% and 33% gives NPV with small variations. NPV is negative at 33% and positive at 32%. It means that the discount rate for 0 NPV [IRR] lies between 32% and 33%
	By simple interpolation IRR = 32%+1%*121/(121+288) =	32.30%
	DECISION:
	The IRR of the project is 32.30%.
	The decision rule with IRR is that, all projects with IRR>WACC can be accepted.
	Hence, the project can be accepted.