The Riverton Company, a ski resort, recently announced a $872,590 expansion to l

Question

The Riverton Company, a ski resort, recently announced a $872,590 expansion to lodging properties, lifts, and terrain. Assume that this investment is estimated to produce $142,000 in equal annual cash flows for each of the first 10 years of the project life.

a. Determine the expected internal rate of return of this project for 10 years, using the present value of an annuity of $1 table above. If required, round your final answer to the nearest whole percent.
%

b. Indentify the uncertainties that could reduce the internal rate of return of this project?

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 3.353 2.991 6 4.917 4.355 4.111 3.785 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

a. IRR is the rate of return where PV of cash Inflows will be equal to PV of Cash Outflows

PV of Cash Outflows = PV of cash inflows

$872590 = $142000 * PVAF (10, r%) Where r = IRR

PVAF (10, r%) = $872590 / $142000 = 6.145

as the compound table 6.145 is appearing at 10%. Thus IRR = 10%

2. Identify the uncertainties that could reduce the internal rate of return of this project

a. If the Annual Cash flows increases over $142000 it will result in reduction of IRR

b. in the same way reduction in initial cost of $872590 will result in reduction of IRR

c.Government subsidies will also result in reduction of IRR

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