Question

In: Finance

A project has the following cash flows for years 0 through 2, respectively: -10,529, 8,541, 8,441....

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?

Solutions

Expert Solution

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

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

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%”


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