Question

Answer Question 1-3

Project A has the following projected cash flows:

Year           Cash Flow

0                -11,235

1                4,400

2                4,400

3                4,400

4                4,400

5                7,400

Q1) The NPV of the above project is $_____. Assume a discount rate of 6%.

		a)9541
		b)20776
		c)17623
		d)6388

Q2) The IRR for the above project is __ %.

		a)21.09
		b)26.76
		c)33.95
		d)31.25

Q3)Which of the following statement is correct?

		a)If the discount rate increases, the IRR will decrease.
		b)If the discount rate increases, the NPV will stay the same.
		c)If the discount rate decreases, the IRR will turn negative.
		d)If the discount rate decreases, the NPV will increase.

Answer 1

1)

NPV = present value of cash inflows - present value of cash outflows

NPV = -11,235 + 4,400 / (1 + 0.06)¹ + 4,400 / (1 + 0.06)² + 4,400 / (1 + 0.06)³ + 4,400 / (1 + 0.06)⁴ + 7,400 / (1 + 0.06)⁵

NPV = $9541

2)

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

NPV = -11,235 + 4,400 / (1 + R)¹ + 4,400 / (1 + R)² + 4,400 / (1 + R)³ + 4,400 / (1 + R)⁴ + 7,400 / (1 + R)⁵

Using trial and error method, i.e., after trying various values for R, lets try R as 31.25%

NPV = -11,235 + 4,400 / (1 + 0.3125)¹ + 4,400 / (1 + 0.3125)² + 4,400 / (1 + 0.3125)³ + 4,400 / (1 + 0.3125)⁴ + 7,400 / (1 + 0.3125)⁵

NPV = 0

Therefore, IRR is 31.25%

3)

d)If the discount rate decreases, the NPV will increase.