Question

An investment project has the following cash flows: CFO = -1,000,000; C01 - C08 = 200,000 each • If the required rate of return is 12%, what decision should be made using NPV? • How would the IRR decision rule be used for this project, and what decision would be reached? • How are the above two decisions related?

NOTE: do it on exal

Answer 1

Calculation of NPV
			12%
Year	Cash Flow-X		PV factor, 1/(1+r)^t	PV-Cash Flow-X
0	$      (1,000,000)		1.0000	$       (1,000,000)
1	$           200,000		0.8929	$            178,571
2	$           200,000		0.7972	$            159,439
3	$           200,000		0.7118	$            142,356
4	$           200,000		0.6355	$            127,104
5	$           200,000		0.5674	$            113,485
6	$           200,000		0.5066	$            101,326
7	$           200,000		0.4523	$              90,470
8	$           200,000		0.4039	$              80,777
			NPV	$              (6,472)
Since NPV is negative, the project should not be undertaken.
calculation of IRR		11.00%	12.00%
Year	Cashflow	PV factor, 1/(1+r)^t	PV factor, 1/(1+r)^t	PV@11%	PV@12%
0	$      (1,000,000)	1.0000	1.0000	$ (1,000,000.00)	$(1,000,000.00)
1	$           200,000	0.9009	0.8929	$       180,180.18	$     178,571.43
2	$           200,000	0.8116	0.7972	$       162,324.49	$     159,438.78
3	$           200,000	0.7312	0.7118	$       146,238.28	$     142,356.05
4	$           200,000	0.6587	0.6355	$       131,746.19	$     127,103.62
5	$           200,000	0.5935	0.5674	$       118,690.27	$     113,485.37
6	$           200,000	0.5346	0.5066	$       106,928.17	$     101,326.22
7	$           200,000	0.4817	0.4523	$         96,331.68	$       90,469.84
8	$           200,000	0.4339	0.4039	$         86,785.30	$       80,776.65
			NPV	$         29,224.55	$       (6,472.05)
		Return=	=Lower rate + Difference in rates*(NPV at lower rate)/(Lower rate NPV-Higher rate NPV)
		Return=	'=11%+ (12%-11%)*(29224.55/(29224.55+6472.05)
		Return=	11.82%
Since IRR is less than the required return, the project should not be undertaken.