Question

Cardinal Company is considering a five-year project that would require a $2,500,000 investment in equipment with a useful life of five years and no salvage value. The company’s discount rate is 12%. The project would provide net operating income in each of five years as follows: Sales $ 2,853,000 Variable expenses 1,200,000 Contribution margin 1,653,000 Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs $ 790,000 Depreciation 500,000 Total fixed expenses 1,290,000 Net operating income $ 363,000 Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using table. 6. What is the project’s internal rate of return? (Round your answer to nearest whole percent.)

Answer 1

Initial Investment = $2,500,000
Useful Life = 5 years

Annual Net Cash Flow = Annual Net Operating Income + Annual Depreciation
Annual Net Cash Flow = $363,000 + $500,000
Annual Net Cash Flow = $863,000

IRR factor = Initial Investment / Annual Net Cash Flow
IRR factor = $2,500,000 / $863,000
IRR factor = 2.89687

PVA of $1 (21%, 5) = 2.92598
PVA of $1 (22%, 5) = 2.86364

Using PV of ordinary annuity table value at n = 5, IRR is 21%

So, IRR of the project is 21%