Question

Warr Company is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC or negative, in both cases it will be rejected.

Year	0	1	2	3	4
Cash flows	-$1565	$400	$400	$400	$400

a. 0.85%

b. 0.76%

c. 0.89%

d. 0.91%

e. 0.78%

Answer 1

Computation of IRR by trial and error method:

Let’s compute NPV of the project at discount rate of 0.8 %

Year	Cash Flow (C)	Computation of PV Factor	PV Factor @ 0.8 % (F)	PV (C x F)
0	-$1,565	1/ (1+0.008)0	1	-$1,565
1	$400	1/ (1+0.008)1	0.992063492063492	396.82540
2	$400	1/ (1+0.008)2	0.984189972285210	393.67599
3	$400	1/ (1+0.008)3	0.976378940759137	390.55158
4	$400	1/ (1+0.008)4	0.968629901546763	387.45196
			NPV1	$3.50493

As NPV is positive let’s compute NPV at discount rate of 0.9 %

Year	Cash Flow (C)	Computation of PV Factor	PV Factor @ 0.9 % (F)	PV (C x F)
0	-$1,565	1/ (1+0.009)0	1	-$1,565
1	$400	1/ (1+0.009)1	0.991080277502478	396.43211
2	$400	1/ (1+0.009)2	0.982240116454388	392.89605
3	$400	1/ (1+0.009)3	0.973478807189681	389.39152
4	$400	1/ (1+0.009)4	0.964795646372331	385.91826
			NPV2	-$0.36206

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

= 0.8 % + [$ 3.50493 x (0.9% - 0.8%)/ ($ 3.50493 – (–$ 0.36206))]

= 0.8 % + [($ 3.50493 x 0.1 %)/ ($ 3.50493 + $ 0.36206)]

= 0.8 % + ($ 0.00350493/ $ 3.86699)

= 0.8 % + 0.00090637162237

= 0.8 % + 0.090637162237 % = 0.89 %

IRR of the project is 0.89 %

Hence option “c. 0.89 %” is correct answer.