Question

Internal Rate of Return Method for a Service Company The Riverton Company, announced a $620,761 million...

Internal Rate of Return Method for a Service Company

The Riverton Company, announced a $620,761 million expansion of lodging properties, ski lifts, and terrain in Park City, Utah. Assume that this investment is estimated to produce $151,000 million in equal annual cash flows for each of the first six years of the project life.

Present Value of an Annuity of $1 at Compound Interest
Year 6% 10% 12% 15% 20%
1 0.943 0.909 0.893 0.870 0.833
2 1.833 1.736 1.690 1.626 1.528
3 2.673 2.487 2.402 2.283 2.106
4 3.465 3.170 3.037 2.855 2.589
5 4.212 3.791 3.605 3.353 2.991
6 4.917 4.355 4.111 3.785 3.326
7 5.582 4.868 4.564 4.160 3.605
8 6.210 5.335 4.968 4.487 3.837
9 6.802 5.759 5.328 4.772 4.031
10 7.360 6.145 5.650 5.019 4.192

a. Determine the expected internal rate of return of this project for six years, using the present value of an annuity of $1 table above.
%

b. Identify the uncertainties that could reduce the internal rate of return of this project?
All of these

Homework Answers

Answer #1
1) IRR = 12%
IRR: IRR stands for Internal rate of return, it is a rate where Net present value is zero.
Steps: To Calculate IRR, we took two random discount rate where at one present value is in negative while in other in positive. Here we took 20% and 28%.
Year Cash Flows PVF PVF Present Value at Present Value at
10% 15% 10% 15%
0             (620,761) 1.00000 1.000             (620,761)             (620,761)
1               151,000 0.90909 0.86957               137,273               131,304
2               151,000 0.82645 0.75614               124,793               114,178
3               151,000 0.75131 0.65752               113,449                  99,285
4               151,000 0.68301 0.57175               103,135                  86,335
5               151,000 0.62092 0.49718                  93,759                  75,074
6               151,000 0.56447 0.43233                  85,236                  65,281
Net Present Value                  36,883               (49,304)
IRR = Lower Discount Rate + [Lower Rate NPV / (Lower Rate NPV - Higher Rate NPV)] * (Higher Discount Rate - Lower Discount Rate)
By putting above values in the give formula we get IRR = 12%
2) Following are the uncertainicities
a) Fluctuation is cash flow
b) Change in market rate of interest during the project
c) Fluctuations in amount of initial investment
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