Question

Elliott Dumack must earn a minimum rate of return of 15% to be adequately compensated for the risk of the following​ investment:

a. Use​ present-value techniques to estimate the yield on this investment.

b. On the basis of your finding in part a​, should Elliott make the proposed​ investment?

Initial Investment   $21,644
End of Year   Income
1   $12,149
2   $3,573
3   $6,191
4   $4,012
5   $2,100

Answer 1

A) Using financial calculator to calculate IRR or yield on investment

Step 1: Press CF

Inputs: C0= -21,644

C1= 12,149. Frequency= 1

C2= 3,573 Frequency= 1

C3= 6,191. Frequency= 1

C4= 4,012. Frequency= 1

C5= 2,100. Frequency= 1

Step 2 : press IRR

Irr= compute

We get, yield on investment as 12.491%

For cross verification (optional)

NPV = - initial investment + cash flow / (1+r)^n

= -21,644 + 12,149 / (1+0.15)^1 + 3,573/(1+0.15)^2 + 6,191/(1+0.15)^3 + 4,012/(1+0.15)^4 + 2,100/(1+0.15)^5

= -21,644 + 12,149/1.15 + 3,573/(1.15)^2 + 6,191/(1.15)^3 + 4,012(1.15)^4 + 2,100(1.15)^5

= -21,644 + 10,564.35 + 3,573/1.3225 + 6,191/1.5209 + 4,012/1.7490 + 2,100/2.0114

= -21,644 + 10,564.35 + 2,701.70 + 4,070.62 + 2,293.88 + 1,044.05

= -21,644 + 20,674.60

= -$969.40

B) As the yield on investment is 12.491%, which is less than the hurdle rate of 15% , Elliot should not make the proposed investment.