In: Finance
Ans:
IRR is found using trial and error method.
we found out whether the value of cash flows becomes zero at a particular rate , if not we out the value at another rate. we will find the difference between the rate and value and found at what rate the value will be equal to zero .
Step 1: Find the present value of cash flows at 10 % rate.
Present value factor (1/(1+rate)^n | Present value factor | Cash flows | Present value |
1/(1.10) | 0.909090909 | 45000 | 40909.09091 |
1/(1.10)^2 | 0.826446281 | 38000 | 31404.95868 |
1/(1.10)^3 | 0.751314801 | 52000 | 39068.36965 |
1/(1.10)^4 | 0.683013455 | 320000 | 218564.3057 |
Present value of cash flows | 329947 | ||
Initial investment | 300000 | ||
29947 |
Step 1: Find the present value of cash flows at 15 % rate. | |||
Present value factor (1/(1+rate)^n | Present value factor | Cash flows | Present value |
1/(1.15) | 0.869565217 | 45000 | 39130.43478 |
1/(1.15)^2 | 0.756143667 | 38000 | 28733.45936 |
1/(1.15)^3 | 0.657516232 | 52000 | 34190.84409 |
1/(1.15)^4 | 0.571753246 | 320000 | 182961.0386 |
Present value of cash flows | 285016 | ||
Initial investment | 300000 | ||
-14984 |
Step 3. The value at the both rates are subtracted to find the amount at 1%
29947- ( 14984) = 44,931. This is for (10-15) = 5%
44,931 is for 5 %
for 1%, $ 8986.189.
The value of present value of cash flows left a balance of 29947 at 10% rate.
we need to find what more the rate should be to make this balance to zero , 29,947 / 8986.189 = 3.3325 %
The rate to be increased from 10% by 3.3325 % so the cash flows will be zero, 10 + 3.3325 = 13.3325 %
IRR = 13.3325 %