Question

a-Define Internal rate of return and state whether it is a dollar amount of a percentage rate?

b- what is capital recovery cost?

c- you wish to endow a scholarship for student to receive 10,000 each year. The program will last for a very long time. you expect to generate an average intrest rate of 12% per year. Ignoring administrative expenses what is the governing equation to analyze this situation? what amount must you deposit at t=0 to fund such a program?

Answer 1

a) Internal rate of return is the return of the project where present value of all future benefits of the project and initial capital investment of the project is same. In other words where NPV of the project is zero. It is calculated to identify the profitability of the project. Project should be accepted where rate of return of the project is equal or higher than the Internal rate of return. It not state actual the dollar amount of percentage rate of the project however it shows the percentage rate instead for the dollar amount.

b) Every investment required some initial capital investment for the project to start the project. to identify and evaluate the annual cost and benefit this initial capital investment should be spread through the life of the project. return calculated on the initial investment is called capital recovery.

c) Amount required to deposit in the present to receive the amount of 10000 every year at the rate of 12% with the life of project id infinite.

Formula = Future continuous cash flow / Rate of return

= 10000 / 0.12

= 83333.33