Question

Prior to the project being shut down the cost of the plant had risen to $7.5 billion and projections were a 1% increase each year in yearly income (income in year one is $200 million, year two $202 million, etc.) due to approved rate increases to customers. Based on the new information what would be the IRR for the project?

Answer 1

The IRR if the project can be obtained through the same formula we apply in dividend growth model. Also we know that the IRR will be the rate at which NPV is 0. So we will keep equal the cost and present value of perpetual growth cash flow.

So initial investment= Cash flow in year 1/(IRR-growth rate)

We converted billion into millions for the same classifcation.

$ 7500 mn = $ 200 mn/(IRR-1%)

By cross multiplication

$7500(IRR-1%) = $200 mn

IRR-1% = 200/7500

IRR-1% = 0.0266 or 2.666%

IRR = 2.66%+1%

IRR = 3.66%