Question

Halla Enterprises is considering the following three investments: Let's say the appropriate discount rate for the investment is 15%.

Year	Cash Flow
0	-6,000		-10,000		-4,000
1	3,000		2,000		1,000
2	3,000		4,000		4,000
3	3,000		8,000		6,000
4	3,000		6,000		0
5	3,000		1,000		0

1. Calculate the net present value of each investment.

2. What is the internal return on each investment?

3. Which investment plan do you think is the most economical? Explain its validity.

(1 Won = 1, No calculate for dollar)

Answer 1

The NPV of each investment is :

CF0 = ($6000)

CF1 to CF5  = $3000

So, the NPV is :

= ($6000) + $3000/ 1.15^1 + $3000/1.15^2 + ...... $3000/1.15^5

= $4056.47 ( rounded off to two decimal places)

IRR = 41.0415%

Simialrly, The NPV of second investment is :

= $3951.5312

IRR = 29.6%

Simialrly, the NPV of the third investment is :

= $3839.23 ( rounded off to two decimal places)

IRR = 53.64

2. The IRR is the rate at which the NPV is zero,

So, the IRR of the first investment is :

($6000) + $3000/(1 + IRR)^1 + $3000/(1 + IRR)^2 + ..... $3000/(1 + IRR)^5 = 0

So, the IRR is : 41.04

Simialrly, IRR for second investment is :

= 29.6%

IRR for the third investment is

= 53.64%

The third investment is the most economical, as it gives the highest IRR at the minimum investment. The third investment has the minimum investment amount and the NPV is also positive and high plus the IRR is the highest among all the three investments.