Question

Internal Rate of Return Method The internal rate of return method is used by Testerman Construction Co. in analyzing a capital expenditure proposal that involves an investment of $75,285 and annual net cash flows of $15,000 for each of the 10 years of its useful life. Present Value of an Annuity of $1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 1.833 1.736 1.690 1.626 1.528 3 2.673 2.487 2.402 2.283 2.106 4 3.465 3.170 3.037 2.855 2.589 5 4.212 3.791 3.605 3.353 2.991 6 4.917 4.355 4.111 3.785 3.326 7 5.582 4.868 4.564 4.160 3.605 8 6.210 5.335 4.968 4.487 3.837 9 6.802 5.759 5.328 4.772 4.031 10 7.360 6.145 5.650 5.019 4.192 a. Determine a present value factor for an annuity of $1 which can be used in determining the internal rate of return. If required, round your answer to three decimal places. b. Using the factor determined in part (a) and the present value of an annuity of $1 table above, determine the internal rate of return for the proposal. %

Answer 1

Answer)

Calculation of Internal rate of return

Internal rate of return is the rate at which the present value of cash inflows is equal to the present value of cash outflows. The internal rate of return can be calculated by computing the approximate present value of annuity of $ 1.

Approximate Present value of annuity $ 1 = Initial cash outflow/ Annual cash inflows

                                                                              = $ 75,285/ $ 15,000

                                                                              = 5.019

On a perusal of present value of annuity of $ 1 table, this value (i.e. 5.019) is found in 10 years row and the corresponding rate is 15%.

Thus the internal rate of return is 15%.