Question

ROVNO Ltd. just invested $50 000 into a new local network. Services provided by the network will bring $15 000 per year in the next five years. The following information is given:

- Real MARR = 10%

- Expected annual inflation = 2%

- The network will be sold for salvage after five years; its depreciation rate is 20%

Is this a good investment in terms of the internal rate of return?

Answer 1

It is necessary to calculate the salvage value of the network at the end of its useful life,

S= BV_db(5) = P * (1-d)⁵ = 50000 * (1-0.2)⁵ = $16384

Since all cash flows are expressed in current (actual) dollars, it is necessary to calculate the actual MARR:

MARR_{A =} MARR_{R + +} MARR_R x = 0.1 + 0.03 + 0.1 * 0.03 = 0.133 or 13.3%

This is the rate we have to compare the IRR with. The actual IRR can be found from the following euation:

15000 * (P/A, IRR, 5) + 16384 * (P/F, IRR, 5) = 50000

Actual IRR = 0.211 or 21.1%.

Since the actual IRR exceeds actual MARR, this is a good investment.