Cheyenne Company is considering a long-term investment project called ZIP. ZIP w

Question

Cheyenne Company is considering a long-term investment project called ZIP. ZIP will require an investment of $141,328. It will have a useful life of 4 years and no salvage value. Annual cash inflows would increase by $88,600, and annual cash outflows would increase by $40,200. The company’s required rate of return is 12%.

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Calculate the internal rate of return on this project. (Round answers to 0 decimal places, e.g. 15%.)

Determine whether this project should be accepted?

Explanation / Answer

Solution:

Investment amount = $141,328

Annual increase in net cash inflows = $88,600 - $40,200 = $48,400

Let IRR of project is i

Now at IRR present value of incremental cash inflows will be equal to initial investment.

Therefore

$48,400 * Cumulative PV factor at IRR for 4 periods = $141,328

Cumulative PV factor at IRR for 4 periods = 2.92

The cumulative PV factor at 13% for 4 periods = 2.97447

Cumulative PV factor at 14% for 4 periods = 2.91371

Therefore cumulative PV factor 2.92 falls between discount rate of 13% to 14%

Hence IRR of the project is between 13% and 14%.

As IRR of project is higher than minimum required return of 12%, therefore project should be accepted.

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