The internal rate of return method is used by Testerman Construction Co. in analyzing a capital expenditure proposal that involves an investment of $129,240 and annual net cash flows of $36,000 for each of the six years of its useful life. This information has been collected in the Microsoft Excel Online file. Open the spreadsheet, perform the required analysis, and input your answers in the question below.
Determine the internal rate of return for the proposal.
Answer:
Calculation of Internal rate of return:
| Particulars | Period | Amount | PVF@10% | Present Value | PV@20% | Present Value |
| Outflows: | ||||||
| Capital expenditure | 0 | $129,240 | 1 | $129,240 | 1 | $129,240 |
| Total Outflow (a) | $129,240 | $129,240 | ||||
| Inflow: | ||||||
| Year -1 | 1 | $36,000 | 0.909 | $32,724 | 0.833 | $29,988 |
| Year -2 | 2 | $36,000 | 0.826 | $29,736 | 0.694 | $24,984 |
| Year -3 | 3 | $36,000 | 0.751 | $27,036 | 0.579 | $20,844 |
| Year -4 | 4 | $36,000 | 0.683 | $24,588 | 0.482 | $17,352 |
| Year -5 | 5 | $36,000 | 0.621 | $22,356 | 0.402 | $14,472 |
| Year-6 | 6 | $36,000 | 0.564 | $20,304 | 0.335 | $12,060 |
| Total Inflows (b) | $156,744 | $119,700 | ||||
| Net Present Value (a-b) | $27,504 | ($9,540) |
Internal rate of return = 10% + {($27,504/$37,044) x 10%}
= 17.42%
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