In: Accounting
1.) If a project has an internal rate of return of 13% and a negative net present value, which of the following statements is true regarding the discount rate used for the net present value computation?
a. The discount rate must have been greater than 13%. |
b. The discount rate must have been equal to 13%. |
c. The discount rate must have been less than 13%. |
d. The discount rate must have been 0%. 2.) If a project's net present value is positive, the internal rate of return is:
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Internal Rate of Return (IRR) is the rate where Net Present Value (NPV) is Zero.
1. Based on the above statement we can conclude that, If a project has an internal rate of return of 13% and a negative net present value then discount rate is greater than IRR. Let us understand this by an example
Example :
Consider a situation in which by investing $ 9,000 in a year, we receive yearly payments of $ 2,500 each, plus $ 4,000 in the third year. By solving this we get a IRR of 11.2%
Year | Cash Flow | DCF @ 11.2% | Present Value |
0 | (9000) | 1.00 | (9000) |
1 | 2500 | 0.8933 | 2249 |
2 | 2500 | 0.8088 | 2022 |
3 | 2500 | 0.7273 | 1819 |
3 | 4000 | 0.7273 | 2910 |
NPV | 0 |
Consider Discount rate as 12%, then the table will look as follows
Year | Cash Flow | DCF @ 12% | Present Value |
0 | (9000) | 1.00 | (9000) |
1 | 2500 | 0.8929 | 2232.14 |
2 | 2500 | 0.7972 | 1992.98 |
3 | 2500 | 0.7118 | 1779.45 |
3 | 4000 | 0.7118 | 2847.12 |
NPV | (148.30) |
So from the above data we can understand that when Discount rate is greater the IRR, NPV will be negative.
2. We can also conclude that when NPV is positive Discount rate is less than IRR