Question

You are considering an investment with the following cash flows. If the required rate of return for this investment is 16.5 percent, should you accept the investment based solely on the internal rate of return rule? Why or why not?

Year: 0, 1, 2, 3

Cash Flow: -152000, 98,200, 102,300, -4,900

A.	Yes; The IRR exceeds the required return.

B.	Yes; The IRR is less than the required return.

C.	No; The IRR is less than the required return.

D.	No; The IRR exceeds the required return.

E.	You cannot apply the IRR rule in this case.

Answer 1

Let the IRR be x.

Now , Present Value of Cash Outflows=Present Value of Cash Inflows

152,000 = 98,200 /(1.0x) + 102,300 / (1.0x)^2 -4,900/ (1.0x)^3

Or x= 18.920%

Hence the IRR is 18.92%

The required rate of return for this investment is 16.5 percent and hence the IRR is clearly greater than the required rate of return for this investment.

As per the IRR Rule, if the IRR is greater than the required rate of return, the investment must be accepted.

Hence the correct answer is A. Yes; The IRR exceeds the required return.