Question

Assume that an industrial building can be purchased for $1,500,000 today, is expected to yield cash flows of $80,000 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) 6.78%

C) 9.20%

D) 10.37%

Answer 1

Compute the internal rate of return (IRR), using the equation as shown below:

Building cost = {Year 1 cash flow/ (1 + Rate)} + {Year 2 cash flow/ (1 + Rate)2} + {Year 3 cash flow/ (1 + Rate)3} + {Year 4 cash flow/ (1 + Rate)4} + {Year 5 cash flow/ (1 + Rate)5} + {Terminal cash flow/ (1 + Rate)5}

$1,500,000 = {$80,000/ (1 + Rate)} + {$80,000/ (1 + Rate)2} + {$80,000/ (1 + Rate)3} + {$80,000/ (1 + Rate)4} + {$80,000/ (1 + Rate)5} + {$1,625,000/ (1 + Rate)5}

After solving the above-mentioned equation on the financial calculator, the IRR comes out to be 6.78%.