Question

Sharon is making an investment of $80,000 today and expects to receive $2,000 each year for the next five years. At the end of the fifth year, a sum of $100,000 will be returned. What is the internal rate of return compounded annually on this investment?

a) 6.84% b) 6.86% c) 6.88% d) 7.02%

Answer 1

		6%	7%
Period	Cash Flow	Discountig Factor [1/(1.06^period)]	PV of cash flows (cash flow*discounting factor)	Discountig Factor [1/(1.07^period)]	PV of cash flows (cash flow*discounting factor)
0	-80000	1	-80000	1	-80000
1	2000	0.9433962	1886.79245	0.9345794	1869.158879
2	2000	0.8899964	1779.99288	0.8734387	1746.877457
3	2000	0.8396193	1679.23857	0.8162979	1632.595754
4	2000	0.7920937	1584.18733	0.7628952	1525.790424
5	102000	0.7472582	76220.3336	0.7129862	72724.59031
		NPV =	3150.54486	NPV =	-500.98718

IRR is the rate of return at which NPV=0

Here, NPV@6% is positive and @7% is negative.

Therefore, IRR is between 6% and 7%

IRR = Rate at which positive NPV + [Positive NPV/(Positive NPV-Negative NPV)]

= 6% + [3150.54/(3150.54-(-500.99)]

= 6% + [3150.54/3651.53]

= 6% + 0.86% = 6.86%