Question

An investment project has the following cash flows: CF0 = -1,200,000; C01 – C05 = 300,000 each

If the required rate of return is 12%, calculate IRR= (   )%.

Answer 1

Computation of IRR using trial and error method:

Let’s compute NPV at discount rate of 7 %

Year	Cash Flow (C)	Computation of PV Factor	PV Factor @ 7 % (F)	PV (C x F)
0	-$1,200,000	1/ (1+0.07)0	1	-$1,200,000
1	300,000	1/ (1+0.07)1	0.9345794392523	280,373.831776
2	300,000	1/ (1+0.07)2	0.8734387282732	262,031.618482
3	300,000	1/ (1+0.07)3	0.8162978768909	244,889.363067
4	300,000	1/ (1+0.07)4	0.7628952120475	228,868.563614
5	300,000	1/ (1+0.07)5	0.7129861794837	213,895.853845
			NPV1	$30,059.230784

As NPV is positive, let’s compute NPV at discount rate of 8 %

Year	Cash Flow (C)	Computation of PV Factor	PV Factor @ 8 % (F)	PV (C x F)
0	-$1,200,000	1/ (1+0.08)0	1	-$1,200,000
1	300,000	1/ (1+0.08)1	0.9259259259259	277,777.777778
2	300,000	1/ (1+0.08)2	0.8573388203018	257,201.646091
3	300,000	1/ (1+0.08)3	0.7938322410202	238,149.672306
4	300,000	1/ (1+0.08)4	0.7350298527965	220,508.955839
5	300,000	1/ (1+0.08)5	0.6805831970338	204,174.959110
			NPV2	-$2,186.988877

IRR = R1 + [NPV1 x (R2 – R1)/ (NPV1 – NPV2)]

= 7 % + [$ 30,059.230784 x (8 % - 7%)/ ($ 30,059.230784– (-$ 2,186.988877))]

= 7 % + [($ 30,059.230784 x 1 %)/ ($ 30,059.230784 + $ 2,186.988877)]

= 7 % + ($ 300.59230784/ $ 32246.219661)

= 7 % + 0.009321784

= 7 % + 0.93 % = 7.93 %

IRR of the project is 7.93 %