Question

A firm has projected future cashflows as follows: $11,000, $14,000, and $10,000 in Year 1, 2, and 3, respectively.

1. If the required initial investment amount is $26,000 today and the required return is 14%, what is the NPV?

2. If the NPV is negative, calculate the IRR. At what discount rate does the project NPV turn positive?

Answer 1

Cash Flows:
Year 0 = -$26,000
Year 1 = $11,000
Year 2 = $14,000
Year 3 = $10,000

Answer a.

Required Return = 14%

Net Present Value = -$26,000 + $11,000/1.14 + $14,000/1.14^2 + $10,000/1.14^3
Net Present Value = $1,171.38

Answer b.

Let IRR be i%

Net Present Value = -$26,000 + $11,000/(1+i) + $14,000/(1+i)^2 + $10,000/(1+i)^3
0 = -$26,000 + $11,000/(1+i) + $14,000/(1+i)^2 + $10,000/(1+i)^3

Using financial calculator, i = 16.69%

Internal Rate of Return = 16.69%

Therefore, project NPV will turn positive if discount rate is less than 16.69%.