Question

You’re given the following cash flows for a project. The WACC of your firm is 12%. What is the IRR of this project using the discounting approach?

Period	Project A
0	-$500 000
1	$700 000
2	$600 000
3	-$900 000

The answer is 9.44%, I need an in-depth solution.

Answer 1

In the discounting approach, all negative cash flows are discounted back to the present value at the WACC and added back to the initial cost.

time 0 = $ 1,140,602.2

time 1 = $ 700,000

time 2 = $ 600,000

The IRR is the discount rate that makes the present value of the cash inflows of a project equal to its initial investment.

In the above equation, we have to solve for the value of r which is the internal rate of return.

The value of r is obtained by trial and error approach.

If we consider r = 8%, the discounted value of the positive cash flows will be

The present value of the positive cash flows is greater than the initial cost.

Let r = 9%

At r = 9%, the present value of the positive cash flows is greater than the initial cost.

Let r = 10%

At r = 10%, the present value of the positive cash flows is lesser than the initial cost.

The value of IRR lies between 9 % and 10%

IRR = 9.44%