Question

Growth enterprise believes its latest product which will cost $ 80,000 to install will generate a perpetual growing stream of cash flows, cash flows after the end of the first year will be $5,000, and cash flows in the future years are expected to grow indefinitey at an annual rate of 5% If the discount rate for this project is 10% what is the project NPV? (Do not round intermediate calculations) What is the IRR? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places)

Answer 1

Information provided:

Initial investment= $80,000

Cash flow at the end of the 1^st year= $5,000

Discount rate= 10%

Growth rate= 5%

1.The net present value is computed as:

= Present value – Initial investment

Present value is computed as below:

= Cash flow at the end of year 1/ Discount rate – Growth rate

= $5,000/ 0.10 – 0.05

= $100,000.

Net present value:

NPV= PV - Initial investment

        = $100,000 - $80,000

        = $20,000.

2.Internal rate of return is the rate that makes the net present value equal to zero.

NPV= PV - Initial investment

$0= Cash flow at the end of year 1/ Discount rate – Growth rate - Initial investment

$0= $5,000/ r – 0.05- $80,000

$80,000= $5,000/ r – 0.05

r – 0.05= $5,000/ $80,000

r – 0.05= 0.0625

r= 0.0625 +_ 0.05

= 0.1125*100

= 11.25%

Therefore, the internal rate of return is 11.25%.

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