Question

Assume that an industrial building can be purchased for $1,700,000 today, is expected to yield cash flows of $125,000 for each of the next five years (with the cash flows occurring at the end of each year), and can be sold at the end of the fifth year for $1,625,000. Calculate the internal rate of return (IRR) for this transaction.

A) 3.14%

B) 6.58

C) 9.20%

D) 10.37%

19) For Question #18, assume you don’t know what the purchase price is. What price would you want to pay in order to obtain a return of 8%

A) Can’t determine from these facts

B) $1,712,000

C) $1,855,678

D) $1,605,036

Answer 1

a.Let irr be x%
At irr,present value of inflows=present value of outflows.

1,700,000=125,000/1.0x+125,000/1.0x^2+125,000/1.0x^3+125,000/1.0x^4+125,000/1.0x^5+1,625,000/1.0x^5

Hence x=irr=6.58%(Approx).

b.We need to calculate the present value of inflows at the rate of 8%;ie:

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=125,000/1.08+125,000/1.08^2+125,000/1.08^3+125,000/1.08^4+125,000/1.08^5+1,625,000/1.08^5

=$1605036(Approx)