The internal rate of return (IRR) method uses present value concepts to compute the rate of return
Question:
The internal rate of return (IRR) method uses present value concepts to compute the rate of return from a capital investment proposal based on its expected net cash flows. This method, sometimes called the time-adjusted rate of return method, starts with the proposal's net cash flows and works backward to estimate the proposal's expected rate of return.
Internal Rate of Return Calculation (Even Cash flows)
| IRR Factor = | Investment |
| Annual cash flows |
If a project has a 6-year life, requires an initial investment of $174,200, and is expected to yield annual cash flows of $40,000, what is the internal rate of return?
| IRR Factor = | $------- | = select : 4.355, 4.111, 4.486 |
| $------- |
The calculated value corresponds to which percentage in the table for the present value of ordinary annuities? (Present Value of an Annuity of $1 at Compound Interest.)
Select: 10%, 12%, 9%
APPLY THE CONCEPTS: Net present value
Project A
This project requires an initial investment of $139,590. The project will have a life of 4 years. Annual revenues associated with the project will be $90,000 and expenses associated with the project will be $45,000 for an annual net cash flow of $--------------.
Note: Enter cash flows as positive numbers.
| | Cash Flows |
| Year 0 | -$139,590 |
| Year 1 | ---------- |
| Year 2 | --------- |
| Year 3 | -------- |
| Year 4 | --------- |
Project B
This project requires an initial investment of $129,600. The project will have a life of 4 years. Annual revenues associated with the project will be $100,000, and expenses associated with the project will be $60,000, for an annual net cash flow of $ --------------.
| | Cash Flows |
| Year 0 | -$129,600 |
| Year 1 | ------------ |
| Year 2 | --------- |
| Year 3 | -------- |
| Year 4 | -------- |
The cost of capital for the company is 6%.
Present Value Tables
Present Value of $1 (a single sum) at Compound Interest.
Present Value of an Annuity of $1 at Compound Interest.
Use the minus sign to indicate a negative NPV. If an amount is zero, enter"0".
| Project A NPV Analysis | |||
| Year | Cash Flow | Discount Factor | Present Value |
| 0 | $139,590 | 1.000 | $139,590 |
| 1–4 | 45,000 | select: 3.465, 0.792, 3.24 | ------------- |
| NPV | | | $ ---------- |
| Project B NPV Analysis | |||
| Year | Cash Flow | Discount Factor | Present Value |
| 0 | $129,600 | 1.000 | $129,600 |
| 1–4 | 40,000 | select 3.465, 0.792, 3.24 | ------------ |
| NPV | | | $--------- |
Based upon net present value, which project has the more favorable profit prospects?
select Project A , Project B , Either project
APPLY THE CONCEPTS: Internal rate of return
Calculate the internal rate of return for Project A and Project B (defined previously). Enter the IRR with the percent sign (i.e. 4%).
Project A: IRR Analysis
With an initial investment of $139,590 and annual cash flows of $-----------, the internal rate of return for Project A is ------------.
Project B: IRR Analysis
With an initial investment of $129,600 and annual cash flows of $-----------, the internal rate of return for Project B is -------------.
Expert Answer:
Internal Rate of Return is a rate at which net present value of all cash flows is equal to one It is ... View the full answer
