Question

A project which has an outlay of $407,328 will provide a cash flow of $80,000 for 15 years.

i) What is the IRR?

ii) If your required rate of return is 32 per cent calculate the NPV and determine whether you should accept the project?

iii) If you have arbitrarily set the required return at 32 per cent but the market rate of return for a project with this level of risk is 16 per cent should the project be accepted?

Answer 1

Ans.

i)

Year	Cash Flows
0	$ (407,328.00)
1	$      80,000.00
2	$      80,000.00
3	$      80,000.00
4	$      80,000.00
5	$      80,000.00
6	$      80,000.00
7	$      80,000.00
8	$      80,000.00
9	$      80,000.00
10	$      80,000.00
11	$      80,000.00
12	$      80,000.00
13	$      80,000.00
14	$      80,000.00
15	$      80,000.00
IRR	18%

ii)

Year	Cash Flows	Present Value Factor @ 32%	Present Value
0	$ (407,328.00)	1	$ (407,328.00)
1	$      80,000.00	0.757575758	$      60,606.06
2	$      80,000.00	0.573921028	$      45,913.68
3	$      80,000.00	0.434788658	$      34,783.09
4	$      80,000.00	0.329385347	$      26,350.83
5	$      80,000.00	0.249534354	$      19,962.75
6	$      80,000.00	0.189041177	$      15,123.29
7	$      80,000.00	0.143213013	$      11,457.04
8	$      80,000.00	0.108494707	$        8,679.58
9	$      80,000.00	0.08219296	$        6,575.44
10	$      80,000.00	0.062267394	$        4,981.39
11	$      80,000.00	0.047172268	$        3,773.78
12	$      80,000.00	0.035736567	$        2,858.93
13	$      80,000.00	0.027073157	$        2,165.85
14	$      80,000.00	0.020509967	$        1,640.80
15	$      80,000.00	0.015537854	$        1,243.03
NPV	$ (161,212.46)

The NPV is negative and hence the project should not be accepted.

iii)

Year	Cash Flows	Present Value Factor @ 16%	Present Value
0	$ (407,328.00)	1	$ (407,328.00)
1	$      80,000.00	0.862068966	$      68,965.52
2	$      80,000.00	0.743162901	$      59,453.03
3	$      80,000.00	0.640657674	$      51,252.61
4	$      80,000.00	0.552291098	$      44,183.29
5	$      80,000.00	0.476113015	$      38,089.04
6	$      80,000.00	0.410442255	$      32,835.38
7	$      80,000.00	0.35382953	$      28,306.36
8	$      80,000.00	0.305025457	$      24,402.04
9	$      80,000.00	0.26295298	$      21,036.24
10	$      80,000.00	0.226683603	$      18,134.69
11	$      80,000.00	0.1954169	$      15,633.35
12	$      80,000.00	0.168462844	$      13,477.03
13	$      80,000.00	0.14522659	$      11,618.13
14	$      80,000.00	0.125195336	$      10,015.63
15	$      80,000.00	0.107927014	$        8,634.16
NPV	$      38,708.49

Now the NPV is positive this project should be accepted.