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In: Accounting

The manager of Keebee, Inc. is considering a new project that would require an initial investment...

The manager of Keebee, Inc. is considering a new project that would require an initial investment of $1,197,810.  The cost of capital or the required rate of return of this company is 10 percent.  This project will generate an annual cash inflow of $300,000 in the following five years.  

  1. Calculate the net present value (NPV) of this project.  Indicate whether or not this project is acceptable.
  1. Calculate the internal rate of return (IRR) of this project.

Solutions

Expert Solution

Computaton of Net Present Value (NPV):

Initial cash outlay      (a)                                   1197810

Present value of cash inflows (b)

(300000 X cumulative discount factor 3.790)         1137000

                                                                          -------------------

NPV (b-a)                                                                  - 60810

                                                                        ===============

Ths project should not be accepted as the NPV is negatve.

Computaton of Internal Rate of Return (IRR):

To arrive at IRR, we need to compute NPV at a different rate randomly, say 6%.

Initial cash outlay      (a)                                   1197810

Present value of cash inflows (b)

(300000 X cumulative discount factor 4.210)         1263000

                                                                          -------------------

NPV (b-a)                                                                   65190

                                                                        ===============

IRR = LR + [(NPV at LR/NPV at LR-NPV at HR) X (HR-LR)]

Where LR = lower rate and HR = higher rate, here LR = 6% and HR = 10%

             = 6 + (65190/65190+60810) X 4

             = 6 + 2.06

         IRR = 8.06 %

================

ekkarill92 answered 2 years ago
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