Question

Foster Industries has a project which has the following cash flows:

Year      Cash Flow

0          -$300.00

1          100.00

2          125.43

3             90.12

4 ?

What cash flow will the project have to generate in the fourth year in order for the project to have a 17.3% rate of return?

Answer 1

17.3% rate of return is the internal rate of return (IRR) of the project. And at IRR, net present value (NPV) of the project is 0.

NPV = Present value of cash inflows - Present value of cash outflow

Calculation is as follows:

NPV = -$300 + ($100)(1 / 1.173) + ($125.43)[1 / (1.173)2] + ($90.12)[1 / (1.173)3] [2 & 3 are the powers of (1.173), while viewing answer, it is appearing as if we are multiplying them]

NPV = -$300 + ($100)(0.8525) + ($125.43)(0.7268) + ($90.12)(0.6196)

NPV = -$67.75

$67.75 is the present value of cash flow required in the fourth year.

Now, solving for CF4:

$67.75(1.173)4 = $128.63 [4 is the powers of (1.173), while viewing answer, it is appearing as if we are multiplying them]

Hence, project have to generate $128.63, in the fourth year in order for the project to have a 17.3% rate of return.