Turner Video will invest $92,500 in a project. The firm’s cost of capital is 11 percent. The investment will provide the following inflows. Use Appendix A for an approximate answer but calculate your final answer using the formula and financial calculator methods.
| Year | Inflow | ||
| 1 | $ | 32,000 | |
| 2 | 34,000 | ||
| 3 | 35,000 | ||
| 4 | 40,000 | ||
| 5 | 38,000 | ||
The internal rate of return is 15 percent.
a. If the reinvestment assumption of the net
present value method is used, what will be the total value of the
inflows after five years? (Assume the inflows come at the end of
each year.) (Do not round intermediate calculations and
round your answer to 2 decimal places.)
b. If the reinvestment assumption of the internal
rate of return method is used, what will be the total value of the
inflows after five years? (Use the given internal rate of
return. Do not round intermediate calculations and round your
answer to 2 decimal places.)
c. Which investment assumption is better?
| Reinvestment assumption of IRR | |
| Reinvestment assumption of NPV |
Present value = Future value/(1+i)^n
i = interest rate per period
n= number of periods
a)
cost of capital = 10%
value of inflows after 5 years = FV of cash inflows
= 32000 * 1.11^4 + 34000 * 1.11^3 + 35000 * 1.11^2 + 40000 * 1.11 + 38000
= 220601.21
b)
IRR = 15%
value of inflows after 5 years = FV of cash inflows
= 32000 * 1.15^4 + 34000 * 1.15^3 + 35000 * 1.15^2 + 40000 * 1.15 + 38000
= 237965.45
c)
Since total value of inflows of IRR method greater than reinvestment assumption, Reinvestment assumption of IRR is better
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