Question

Last Tuesday, Green Caterpillar Garden Supplies Inc. lost a porion of its planning and financial data when its server and its backup server crashed. The company's CFO remembers that the internal rate of return (IRR) of project Gamma is 11.3%, but he can't recall how much Green Caterpillar originally invested in the project nor the project's net present value (NPV). However, he found a note that contained the annual net cash flows expected to be generated by Project Gamma. They are:

Year 1 $2,000,000

Year 2 $3,750,000

Year 3 $3,750,000

Year 4 $3,750,000

a. The CFO haas asked you to compute project Gamma's inital investment using the information currently available to you. He as offered the following suggestions and observations:

-A Project's IRR represents the return the project would generate when its NPV is zero or the discounted value of its cashs inflows equals the discounted value of its cash outflows

-when the cash flows are discounted using the project's IRR.

-The level of risk exhibited by project gamma is the same as that exhibited by the company's average project, which means that project gammas net cash flows can be discounted using green caterpillars 9% WACC.

b. Given the datea and hints, Project Gamms's inital invest is _________, and its NPV is _____________?

c. A project's IRR will ________ if the prjoect's cash inflows decrease, and everything else is unaffected.

a. increase

b. stay the same

c. decrease

Answer 1

IRR is rate at which present value of cashinflow= pv of cash out flow

so we first find the pv of cash inflow with irr which ultimately our cash outflow as at time 0 pv factor is 1

	0	1	2	3	4
Cash flows	$0	2,000,000	3,750,000	3,750,000	3,750,000
Discounting factor	1	0.8984725	0.8072530	0.7252947	0.6516574
Present value	$0	1796945	3027199	2719855	2443715

= 9987714

so as are pv of cash ouflow is 9987714 which equal to cash outflow

Now finding NPV at 9%

	0	1	2	3	4
Cash flows	- 9987714	2,000,000	3,750,000	3,750,000	3,750,000
Discounting factor	1	0.917431	0.841679	0.772183	0.708425
PV	- 9987714	1834862	3156296	2895686	2656595

Present value = 555725

(C).

option c is correct i.e if the cash flow decreases and every thing remain constant irr will decreases