Question

In: Finance

A new, limited duration product line will be launched over a two-year period, and is expected...

A new, limited duration product line will be launched over a two-year period, and is expected to produce the net cash flows shown below.

A. What is the net present value and IRR of this investment if the required return is 15%?

B. Is the actual return more or less than the required rate? Why?   

Year 15%
0                   (700)                   (700)
1                   (500)
2                     500
3                 1,000
4                     500
5                     200
NPV
IRR

Solutions

Expert Solution

Ans a NPV is Present value of cash inflows less present value of cash outflows.
Year Cash flows discounting factor for 15% Present Value@15% discounting factor for 25.1% Present [email protected]%
0                                         -700.00 1                             -700.00 1                           -700.00
1                                         -500.00 0.869565217                             -434.78 0.799360512                           -399.68
2                                           500.00 0.756143667                               378.07 0.638977227                            319.49
3                                        1,000.00 0.657516232                               657.52 0.510773163                            510.77
4                                           500.00 0.571753246                               285.88 0.408291897                            204.15
5                                           200.00 0.497176735                                 99.44 0.32637242                              65.27
NPV                               286.12                                0.00
Explaination:-
Internal rate of return is the rate where NPV of the project is zero. To calculate IRR, we should set NPV is equal to zero and solve for discount rate which is the IRR.
Using trial and error method we guessed the discounting rate to be 25.1% .
Ans b Since the IRR > required rate of return i.e. 25.15>15%, it is quite evident that actual return is more then the required rate of return.

jeff jeffy answered 1 year ago
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