Question

Your factory has been offered a contract to produce a part for a new printer. The contract would last for three​ years, and your cash flows from the contract would be

$ 4.99$4.99

million per year. Your upfront setup costs to be ready to produce the part would be

$ 7.91$7.91

million. Your discount rate for this contract is

7.6 %7.6%.

a. What is the​ IRR?

b. The NPV is

$ 5.04$5.04

​million, which is positive so the NPV rule says to accept the project. Does the IRR rule agree with the NPV​ rule?

a. What is the​ IRR?

The IRR is:

Answer 1

a)

IRR is the rate of return that makes initial investment equal to present value of cash inflows

Initial investment = payments * [1 - 1 / (1 + r)^n] / r

7.91 = 4.99 * [1 - 1 / (1 + r)^3] / r

Using trial and error method, i.e., after trying various values for R, lets try R as 40.19%

7.91 = 4.99 * [1 - 1 / (1 + 0.4019)^3] / 0.4019

7.91 = 4.99 * [1 - 0.362952] / 0.4019

7.91 = 4.99 * 1.585091

7.91 = 7.91

Therefore, IRR is 40.19%

b)

Any project that has IRR is greater than discount rate should be accepted. Any project having positive NPV should be accepted. Therefore, IRR rule agrees with NPV