Question

A company is evaluating an investment project with the following forecast cash flows:

Year                         0               1                  2                    3                     4

Cash flow($m)        (6.5)            2.4               3.1                 2.1                   1.8

Using discount rates of 15% and 20%, what is the internal rate of return of the investment project?

Answer 1

Year	Cash Flow	Present value index @15%	Present Value	Present value index@ 20%	Present value
0	(6.5)	1	(6.5)	1	(6.5)
1	2.4	0.869	2.0856	0.833	1.9992
2	3.1	0.756	2.3436	0.694	2.1514
3	2.1	0.658	1.3818	0.578	1.2138
4	1.8	0.572	1.0296	0.482	0.8696
Total of Inflows			6.8406		6.232

IRR is the rate at which present value of Inflows will be equal to the initial outflow of funds.

@15% = 6.8406

@20% = 6.232

So for 5% change there is a decrease of 6.8406 - 6.232 = 0.6086

We should have decrease of 6.8406 - 6.5 = 0.3406

So % decrease required = 0.3406 x 5% ÷ 0.6086 = 2.5%

So IRR = 15 + 2.5% = 17.5%

Hence IRR = 17.5%.