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A firm evaluates all of its projects by applying the IRR rule. If the required returns...

A firm evaluates all of its projects by applying the IRR rule. If the required returns is 14%, should the firm accept the following project?
Year Cash flow
0. -$26000
1. $11000
2. $14000
3. $10000

Solutions

Expert Solution

Step – 1, Firstly calculate NPV at 14%

Net Present Value [NPV] = Present Value of Annual cash flows – Initial Investment

= [11,000 x 0.877192982] + [14,000 x 0.769467528] + [10,000 x 0.674971516] – 26,000

= $ 9649.12 + 10772.55 + 6749.72 – 26,000

= $ 1,171.39

Step – 2, NPV at 14% is positive, Calculate the NPV again at a higher rate, Say 17%

= [11,000 x 0.854700855] + [14,000 x 0.730513551] + [10,000 x 0.624370556] – 26,000

= $9401.71 + 10227.19 + 6243.71 – 26,000

= -127.39 [Negative]

Therefore IRR = R1 + NPV1(R2-R1)

                                   NPV1-NPV2

= 14% + $1,1713.9 (17% - 14%)

             $1,171.39 - (-127.39)

IRR = 14% + 2.70% = 16.70%

DECISION

The Internal Rate of Return [IRR] of the Project(16.70%) is more than the Required rate of return of 14%. Hence, The Project shall be acceptable for Investment

jeff jeffy answered 2 years ago
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