In: Finance
A project has the following cash flows for years 0 through 2, respectively: -10,529, 8,541, 8,441. What is the internal rate of return on this project?
Internal Rate of Return (IRR) for the Project
Step – 1, Firstly calculate NPV at a guessed discount Rate, Say 37% (R1)
Year |
Annual Cash Flow ($) |
Present Value factor at 37% |
Present Value of Cash Flow ($) |
1 |
8,541 |
0.729927 |
6,234.31 |
2 |
8,441 |
0.532793 |
4,497.31 |
TOTAL |
10,731.62 |
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Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment
= $10,731.62 - $10,529
= $202.62
Step – 2, NPV at 37% is positive, Calculate the NPV again at a higher discount rate, Say 39% (R2)
Year |
Annual Cash Flow ($) |
Present Value factor at 39% |
Present Value of Cash Flow ($) |
1 |
8,541 |
0.719424 |
6,144.60 |
2 |
8,441 |
0.517572 |
4,368.82 |
TOTAL |
10,513.43 |
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Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment
= $10,513.43 - $10,529
= -$15.57 (Negative NPV)
The calculation of Internal Rate of Return using Interpolation method is as follows
Therefore IRR = R1 + NPV1(R2-R1)
NPV1-NPV2
= 0.37 + [$202.62 x (0.39 – 0.37)]
$202.62 – (-$15.57)
= 0.37 + [$4.05 / $218.19]
= 0.37 + 0.0168
= 0.3886 or
= 38.86%
“Hence, the Internal Rate of Return (IRR) for the Project will be 38.86%”