The internal rate of return method is used by Testerman Construction Co. in anal

Question

The internal rate of return method is used by Testerman Construction Co. in analyzing a capital expenditure proposal that involves an investment of $69,264 and annual net cash flows of $13,000 for each of the nine years of its useful life.

a. Determine a present value factor for an annuity of $1 which can be used in determining the internal rate of return. If required, round your answer to three decimal places.

b. Using the factor determined in part (a) and the present value of an annuity of $1 table above, determine the internal rate of return for the proposal.

Present Value of an Annuity of $1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 1.833 1.736 1.690 1.626 1.528 3 2.673 2.487 2.402 2.283 2.106 4 3.465 3.170 3.037 2.855 2.589 5 4.212 3.791 3.605 3.352 2.991 6 4.917 4.355 4.111 3.784 3.326 7 5.582 4.868 4.564 4.160 3.605 8 6.210 5.335 4.968 4.487 3.837 9 6.802 5.759 5.328 4.772 4.031 10 7.360 6.145 5.650 5.019 4.192

Explanation / Answer

Answer

à annuity figure of $1 calculation will be as follows:

$ 69,264 = $ 13,000 x $ 1 Annuity factor for 9th year

69,264 / 13,000 = $ 1 Annuity factor for 9th year

$ 1 Annuity factor for 9th year = 5.328

$ 1 Annuity factor for 9th year calculated above = 5.328.

If you look closely as to where this figure (5.328) is falling in the table of annuities provided in the question, you’ll see that it falls under 12%, for 9th year.

Hence, the Internal rate of Return = 12%

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