Question

Casa Del Sol Property Development Company is borrowing $1,875,000. It expects to pay back $415,350 for the next seven years. What is the internal rate of return? Should the firm borrow if r = 12 percent?

A. 12.35 percent, no because IRR > r

B. 11.83 percent, yes, because IRR < r

C. 11.83 percent, no, because IRR < r

D. 15.83 percent, yes, because IRR > r

Answer 1

The correct answer is:

IRR = 12.35%; The firm should borrow as IRR>r

The option should be A, with a correction of the second part.

Calculation of IRR is shown below:

IRR is that discount rate which equates the PV of the
cash inflows with the initial investment.
Hence, $415,350*PVIFA(irr,7) = 1875000
PVIFA(irr,7) = 1875000/415350 =	4.5143
The interest factors for 12% and 13% of n = 7 are	12%	13%
	4.5638	4.4226
So, IRR lies between 12% and 13%.
By simple interpolation, IRR = 12%+1%*(4.5638-4.5143)/(4.5638-4.4226) =	12.35%