Question

Five years ago, a company made a $5 million investment in a new high-temperature material. The product was not well accepted after the first year on the market. However, when it was reintroduced 4 years later, it did sell well during the year. Major research funding to broaden the applications has cost $15 million in year 5. Determine the rate of return for these cash flows (shown below in $1000s). Year Net Cash Flow, $ 0 –5,000 1 4,000 2 0 3 0 4 20,000 5 –15,000 Question 4 options: i* = 48.4% per year i* = 34.6% per year i* = 38.5% per year i* = 44.1% per year

Answer 1

	A	B	C	D	E	F	G	H	I
Year	Net Cash Flows ($000)	Discount rate of $1 when i = 48.4%	Present Value(P V) in ($000) when i = 48.4% A x B	Discount rate of $1 when i = 34.6%	Present Value (P V) in ($000) when i = 34.6% A x D	Discount rate of $1 when i =38.5%	Present Value (P V) in ($000) when i = 38.5% A x F	Discount rate of $1 when i = 44.1%	Present Value (P V) in ($000) when i = 44.1% A x H
0	-5000	-	-5000	-	-5000	-	-5000	-	-5000
1	4000	0.67385	2695.4	0.74294	2971.76	0.72202	2888.08	0.69396	2775.84
2	0	0.45408	0	0.55196	0	0.52132	0	0.48158	0
3	0	0.30598	0	0.41008	0	0.37640	0	0.33420	0
4	20000	0.20619	4123.8	0.30466	6093.2	0.27177	5435.4	0.23192	4638.4
5	-15000	0.13894	-2084.1	0.22635	-3395.25	0.19622	-2943.3	0.16095	-2414.25
Net Present Value in $000 (N P V )			-264.9		669.71		380.18		0

From the above table it is found that N P V becomes $0 when i = 44.1%.Therefore Internal Rate of Return ( IR R) for the project is 44.1%.

Note 1: Here discount rate of $1 is calculated using the formula below -

Where i = interest rates; n= year

Note 2: To get P V we multiply Discount rate of $1 with net cash flow for that particular year.

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