Question

A worker is offered a salary bonus of $2,000 for each of the next two years if he enrolls in a job training program this year. The total cost to the worker, including any forgone earnings, is $3,500. These costs are borne this year.

What is the internal rate of return on this investment?

Would this be a good investment for someone with a discount rate of 6%? What is the highest discount rate a person could have and still find this investment attractive?

Answer 1

Internal rate of return is the rate of return at which Net Present value = 0

i.e. Present Value of Cash outflows =  present value of cash inflows

a.Let IRR be x%

3,500 = 2,000*PVAF(x%, 2 years)

PVAF(x%, 2 years) = 1.75

From present value table, x = 9%

Hence, IRR = 9%

This will be a good investment for someone with a discount rate of 6% since return is close to 9%

The highest discount rate a person could have and still find this investment attractive = 9%