Question

The rate of return is calculated to be between 5% and 8% in a 3 year investment. The present values corresponding to 5% and 8% are $11 and -$6. Using interpolation, calculate the rate of return of the investment.

Options:

6.5

5.0

6.1

6.9

Answer 1

Using Interpolation, calculation of the rate of return of the Investment

Formula = Lower discount rate + Net present value(NPV) at lower Discount Rate   Multiplied by Difference between Two discount rate

   Difference between the two NPV

IN the given question,

Net Present Value at two discount rates and in question two discount rates are 5% and 8% respectively.

1. One that discount rate at which NPV is positive i.e. at 5% rate NPV is $11.   Lower Discount Rate is 5%.

2. Second, that discount rate at which NPV is negative i.e. at 8% rate NPV is -$6. Higher Discount rate is 8%.

3. Difference between two discount rate is 8% - 5% = 3%  

BY putting the value on the above formula we get,

= 5% +   11   Multiplied by 3 %

11 - (6)

   = 5% + 11    Multiplied by 3%   

17

= 5%+ 1.94%

= 6.9%

ANSWER option 6.9%