Question

A company is evaluating an investment project with the following forecast cash flows: Year                         0   

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?

Homework Answers

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%.

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