Question

Capilano Inc. is considering whether to invest in the North Shore automated process, which gives rise to staffing and other cost savings over the existing process. The data below relate to the process.

                                                                    $                                        

Investment outlay                           (400,000)                   

Year 1 annual cost savings            160,000                     

Year 2 annual cost savings            160,000                     

Year 3 annual cost savings            160,000                     

Year 4 annual cost savings            120,000                     

The required return is 15 per cent p.a.

Calculate the internal rate of return for the investment.

Answer 1

Let irr be x%
At irr,present value of inflows=present value of outflows.

400,000=160,000/1.0x+160,000/1.0x^2+160,000/1.0x^3+120,000/1.0x^4

Hence x=irr=19.30%(Approx)