Question

A firm expects cash flows from an initial investment of 1 000 000$. The expected cash flows are as follows:

1.year: 600 000$ , 2.year: 400 000$, 3.year: 350 000$, 4.year: 300 000$

If the cost of capital is 16%, what is approximate IRR of this investment project? Do you accept this investment project?

Answer 1

IRR is that Discount rate, at which NPV is 0

We will calculate NPV at 20% and 25%. then will find out IRR by approximate IRR formula

Year Cash flows P.V.F.@ 25%. P.V.

year 0 -1000000 1.0000 -1000000

Year 1 600000. 0.8000 480000

Year 1 400000 0.6400 256000

Year 3 350000 0.5120. 179200

Year 4 300000 0.4096. 122880

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N.P.V. of cash inflows 38080

Calculation of NPV @28%

Year Cash flows P.V.F.@ 28%. p.v.

year 0 -1000000. 1.0000 -1000000

Year 1 600000. 0.7813 468750

Year 1 400000. 0.6104 244140.625

Year 3 350000 0.4768 166893.0054

Year 4 300000. 0.3725. 111758.709

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P.V. of cash inflows. -8457.660675

IRR formula = Lower rate + (Difference of rates)*(NPV at lower rate - 0)/(Difference of NPV)

25 +(28-25)*(38080-0) /(38080-(-8557.66))

25 + 2.45

27.45%

So, IRR is 27.45%

IRR is more than Cost of capital 16%. so Project should be accepted.