Question

Suppose a particular investment project will generate an immediate cash inflow of $1,000,000 followed by cash outflows of $500,000 in each of the next three years. What is the project’s IRR? Suppose a company’s hurdle rate is 15%, should it accept the project?  I need to learn steps with BA ll plus calculator if needed.

		23%; reject the project
		23%; accept the project
		15%; reject the project
		15%; accept the project

Answer 1

Internal Rate of Return (IRR) for the Project

Step – 1, Firstly calculate NPV at a guessed discount Rate, Say 20% (R1)

Year	Annual Cash Flow ($)	Present Value factor at 20%	Present Value of Cash Flow ($)
1	5,00,000	0.833333	4,16,667
2	5,00,000	0.694444	3,47,222
3	5,00,000	0.578704	2,89,352
TOTAL			10,53,241

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $10,53,241 - $10,00,000

= $53,241

Step – 2, NPV at 20% is positive, Calculate the NPV again at a higher discount rate, Say 24% (R2)

Year	Annual Cash Flow ($)	Present Value factor at 24%	Present Value of Cash Flow ($)
1	5,00,000	0.806452	4,03,226
2	5,00,000	0.650364	3,25,182
3	5,00,000	0.524487	2,62,244
TOTAL			9,90,652

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $9,90,652 - $10,00,000

= -$9,348 (Negative NPV)

Therefore IRR = R1 + NPV1(R2-R1)

                                   NPV1-NPV2

= 0.20 + [$53,241 x (0.24 – 0.20)]

              $53,241 – (-$9,348)

= 0.20 + [$2,130 / $62,589]

= 0.20 + 0.0338

= 0.2338

= 23.38% or

= 23% (Rounded to the nearest whole number)

DECISION

We should accept this investment proposal, since, the Internal Rate of Return for the Project (23%) is greater than the Projects Hurdle Rate (15%).

“Hence, the answer is 23%; accept the project”

NOTE     

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.