Question

87. Should the following project be accepted if the cost of capital is 12%?
Initial Investment is $50,000.

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Years	Cash Flows
1	$25,000
2	$35,000
3	$55,000

	a.	Yes, because the internal rate of return is 10.5%, which is less than 12%.
	b.	Yes, because the internal rate of return is 35%, which is more than 12%.
	c.	No, because the internal rate of return is 8.7%, which is less than 12%.
	d.	Yes, because the internal rate of return is 48%, which is more than 12%.

Answer 1

Internal Rate of Return

The cost of capital is 12%

Years	Inflow	Present Value Factor @12%	Present Value
1	25000	0.8929	22323
2	35000	0.7972	27902
3	55000	0.7118	39149
			89374

Net Present Value = Present Value of Cash Inflows - Initial Investment = 89374 - 50000 = 39374

Calculation with cost of capital is 50%

Years	Inflow	Present Value Factor @50%	Present Value
1	25000	0.6667	16668
2	35000	0.4444	15554
3	55000	0.2963	16297
			48519

Net Present Value = Present Value of Cash Inflows - Initial Investment = 48519 - 50000 = 1481

Lower Discount rate

NPV at Lower Discount rate

NPV at Higher Discount rate

Difference between Lower Discount rate and Higher Discount rate

%

Since IRR is greater than Cost of capital 12%, ACCEPT the project

Answer    D        Yes, because the internal rate of return is 48%, which is more than 12%