Internal Rate of Return Jardin Company produces a variety of gardening tools and

Question

Internal Rate of Return Jardin Company produces a variety of gardening tools and aids. The company is examining the possibility of investing in a new production system that will reduce the costs of the current system. The new system will require a cash investment of $2,303,600 and will produce net cash savings of $400,000 per year. The system has a projected life of nine years. Calculate the internal rate of return for the new production system. Follow the format shown in Exhibit 14B-2 as you complete the requirement below. Round your answer to the nearest whole percentage.

Explanation / Answer

NPV when calculated by taking two percentages is as shown below:

So, the IRR will be between 9% and 10%.

If we round it of to the next whole percentage then the answer will be 10%

Internal rate of return= ra+ NPVa/(NPVa –NPVb ) (rb-ra)

Where ra= Lower discount rate

rb= higher discount rate

Na= NPV at ra

Nb= NPV at rb

So IRR = 9% + 94,000 + (94,000+400) *(10%-9%)

              = 10% (Approx)

Time Cash Flow 10% NPV b 9% NPVa 0 -23,03,600 1 -23,03,600 1 -2303600 1 4,00,000 0.909 3,63,600 0.917 366800 2 4,00,000 0.826 3,30,400 0.842 336800 3 4,00,000 0.751 3,00,400 0.772 308800 4 4,00,000 0.683 2,73,200 0.708 283200 5 4,00,000 0.621 2,48,400 0.65 260000 6 4,00,000 0.564 2,25,600 0.596 238400 7 4,00,000 0.513 2,05,200 0.547 218800 8 4,00,000 0.467 1,86,800 0.502 200800 9 4,00,000 0.424 1,69,600 0.46 184000 12,96,400 -400 94,000

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