Question

Problem 8 is this: Your factory has been offered a contract to produce a part for a new printer. The contract would be for three years and your cash flows from the contract would be $5 million per year. Your up-front setup costs to be ready to produce the part would be $8 million. Your cost of capital for this contract is 8%. a. What does the NPV rule say you should do? b. If you take the contract, what will be the charge in the value of your firm?

I have to answer this question:  Does the IRR rule agree with the NPV rule in problem above?

Show me the steps if whether the IRR rule agrees with NPV rule

Answer 1

Year	Cash Flow
0	- $ 8 million
1	$ 5 million
2	$ 5 million
3	$ 5 million
4	$ 5 million
5	$ 5 million

Discount Rate = 8%

A. NPV

NPV = $ 11.96355 million

Accept the project as NPV is positive.

B. Calculation of IRR

Using Excel You can find IRR it is 56%

We can also solve it using Trial and error method. Let us assume IRR = 50%

For a projects internal rate of return NPV = 0. Calculate the NPV at 50%

NPV = - 8 + 5 * 1.736626

NPV = $ 0.683128 million

Since NPV is not zero therefore increasing rate. Let us assume IRR = 60%

NPV = - $ 8 + $ 5*1.507721

NPV = -$ 0.4614 million

Now using linear interpolation we can determine the IRR

Since IRR is greater than the MARR of 8% therefore accept the project.

So, IRR rule too accepts the project and it is in the same line with the NPV rule because in that case too the project was having positive.

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