Question

1. Assume the following for a project under evaluation:

** The project's life is 4 years.

** The total time zero, initial cost of $55,000.

** The total net operating cash flow each year is $15,000.

** In addition to the terminal year operating cash flow, there is a non-operating, terminal year cash flow of $8,000.

What is the project's IRR? Accept or reject the project? Again, assume the cost of capital for a project of this risk is 7%.

		7%; indifferent to accept or reject
		8.4%; reject
		8.4%; accept
		15.75%, reject
		15.75%: accept

2. Barmin's Corp. has acquired an additional company by purchasing its outstanding stock. Analysts forecast a period of 2 years of extraordinary growth (20 percent), followed by 1 year of unusual growth (10 percent), and finally a normal (sustainable) growth rate of 6.5 percent annually indefinitely. The last dividend was D0= $1.00 per share and the required return is 8.6%. What is D4 (i.e., the dividend expected at end of period 4)?

		1.0000
		1.286
		1.584
		1.687
		1.440

Answer 1

1)

IRR is the rate of return that makes NPV = 0

NPV = Present value of cash inflows - present value of cash outflows

-55,000 + 15,000 / ( 1 + R)¹ + 15,000 / ( 1 + R)² + 15,000 / ( 1 + R)³ + 23,000 / ( 1 + R)⁴ = 0

using trial and error method i.e, trying out different values from the option. Lets try 8.4

-55,000 + 15,000 / ( 1 + 0.084)¹ + 15,000 / ( 1 + 0.084² + 15,000 / ( 1 + 0.084)³ + 23,000 / ( 1 + 0.084)⁴ = 0

0 = 0

8.4%; accept

We will accept the project since IRR is greater than cost of capital.

2)

Year 1 dividend = 1 * 1.2 = 1.2

Year 2 dividend = 1.2 * 1.2 = 1.44

year 3 dividend = 1.44 * 1.1 = 1.584

Year 4 dividend = 1.584 * 1.065 = 1.687