Question

A firm expects cash flows from an initial investment of 1 000 000$. The expected cash flows are as follows:

1.year: 600 000$ , 2.year: 400 000$, 3.year: 350 000$, 4.year: 300 000$

If the cost of capital is 16%, what is approximate IRR of this investment project? Do you accept this investment project?

Answer 1

IRR is the rate of return that makes NPV equal to 0.

NPV = 1,000,000 + 600,000 / (1 + R)¹ + 400,000 / (1 + R)² + 350,000 / (1 + R)³ + 300,000 / (1 + R)⁴

Using trial and error method, i.e., after trying various values for R, lets try R as 27.44%

NPV = 1,000,000 + 600,000 / (1 + 0.2744)¹ + 400,000 / (1 + 0.2744)² + 350,000 / (1 + 0.2744)³ + 300,000 / (1 + 0.2744)⁴

NPV = 0

Therefore, IRR is 27.44%

You should accept the project as the IRR is greater than cost of capital.