(Ignore income taxes in this problem.) The following data pertain to an investme
ID: 2542513 • Letter: #
Question
(Ignore income taxes in this problem.) The following data pertain to an investment in equipment:
Investment in the project
$10,000
Annual net cash inflows
$2,400
Working capital required
$5,000
Salvage value of the equipment
$1,000
Life of the project
8 years
At the completion of the project, the working capital will be released for use elsewhere. The cost of capital (discount rate) is 12%. Should the project be accepted?
Investment in the project
$10,000
Annual net cash inflows
$2,400
Working capital required
$5,000
Salvage value of the equipment
$1,000
Life of the project
8 years
Explanation / Answer
IRR : IRR Means with a particular Percentage rate , At that point the present value become the zero CALCULATION OF THE IRR OF THE PROJECT First we calculate randomly present value with @ 12% discounting rate Particulars Years Cash Flows PVF @ 10% Present Value 0 -$10,000 1.00000 -$10,000.00 Working Capital 0 -$5,000 1.00000 -$5,000.00 1 $2,400 0.90909 $2,181.82 2 $2,400 0.82645 $1,983.47 3 $2,400 0.75131 $1,803.16 4 $2,400 0.68301 $1,639.23 5 $2,400 0.62092 $1,490.21 6 $2,400 0.56447 $1,354.74 7 $2,400 0.51316 $1,231.58 8 $2,400 0.46651 $1,119.62 Salvage 8 $1,000 0.46651 $466.51 Working Capital 8 $5,000 0.46651 $2,332.54 Total $10,200 $603 Net Present Value = $602.87 With PVF of 10% we are getting positive = $602.87 Secondly we calculate randomly present value @ 11 % discounting rate Particulars Years Cash Flows PVF @ 11% Present Value 0 -$10,000 1.00000 -$10,000.00 Working Capital 0 -$5,000 1.00000 -$5,000.00 1 $2,400 0.90090 $2,162.16 2 $2,400 0.81162 $1,947.89 3 $2,400 0.73119 $1,754.86 4 $2,400 0.65873 $1,580.95 5 $2,400 0.59345 $1,424.28 6 $2,400 0.53464 $1,283.14 7 $2,400 0.48166 $1,155.98 8 $2,400 0.43393 $1,041.42 Salvage 8 $1,000 0.43393 $433.93 Working Capital 8 $5,000 0.43393 $2,169.63 Total $10,200 -$46 Net Present Value = -$45.75 With PVF of 11 % we are getting negative = -45.75 In the given case the pv with 10% is coming to postive means the present value is more then 10 % but with 11 % Present value cash flow become negative so the present value is between 10% and 11 % So the differecne in both % net present value is = $602.87 - -$45.75 Total is become = $648.61 So , the difference % = $602.87 "/"By $648.61 So , the difference % = 0.93 So, the IRR = 10.93% Answer = IRR = 10.93% Answer = Project Should not be accepted, Answer = Option 1 = No, the internal rate of return (IRR) is smaller than the cost of capital
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