Question

Cooper Industries is considering a project that would require an initial investment of $101,000. The project would result in cost savings of $62,000 in year 1 and $70,000 in year two. What is the internal rate of return?

Answer 1

Internal Rate of Return (IRR) for the Project

Step – 1, Firstly calculate NPV at a guessed discount Rate, Say 19% (R1)

Year	Annual Cash Flow ($)	Present Value factor at 19%	Present Value of Cash Flow ($)
1	62,000	0.84034	52,101
2	70,000	0.70616	49,431
TOTAL			101,532

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $101,532 - $101,000

= $532

Step – 2, NPV at 19% is positive, Calculate the NPV again at a higher discount rate, Say 20% (R2)

Year	Annual Cash Flow ($)	Present Value factor at 20%	Present Value of Cash Flow ($)
1	62,000	0.83333	51,667
2	70,000	0.69444	48,611
TOTAL			100,278

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $100,278 - $101,000

= -$722 (Negative NPV)

The calculation of Internal Rate of Return using Interpolation method is as follows

Therefore IRR = R1 + NPV1(R2-R1)

                                   NPV1-NPV2

= 0.19 + [$532 x (0.20 – 0.19)]

              $532 – (-$722)

= 0.19 + [$5.22 / $1,254]

= 0.19 + 0.0042

= 0.1942 or

= 19.42%

“Hence, the Internal Rate of Return (IRR) for the Project will be 19.42%”