3. Understanding the IRR and NPV The net present value (NPV) and internal rate o
ID: 2619599 • Letter: 3
Question
3. Understanding the IRR and NPV The net present value (NPV) and internal rate of return (IRR) methods of investment analysis are interrelated and are sometimes used together to make capital budgeting decisions Consider the case of Fuzzy Button Clothing Company: Last Tuesday, its backu 13.8%, but he can't recall how much Fuzzy Button originally invested in the project nor the project's net present value (NPV). However, he found a note that detailed the annual net cash flows expected to be generated by Project Fuzzy Button Clothing Company lost a portion of its planning and financial data when both its main and p servers crashed. The company's CFO remembers that the internal rate of return (IRR) of Project Gamma is Gamma. They are: Year Cash Flovw Year i SI,600,000 Year 2 $3,000,000 Year 3 $3,000,000 Year 4 $3,000,000 The CFO has asked you to compute Project Gamma's initial investment using the information currently available to you. He has offered the following suggestions and observations: A project's IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows equals the discounted value of its cash outflows-when the cash flows are discounted using the project's IRR. The level of risk exhibited by Project Gamma is the same as that exhibited by the company's average project, which means that Project Gamma's net cash flows can be discounted using Fuzzy Button's 9% WACC. Given the data and hints, Project Gamma's initial investment is (rounded to the nearest whole dolar) , and its NPV is A project's IRR will f the project's cash inflows increase, and everything else is unaffectod. MacBookExplanation / Answer
- Project Gamma’s Initial Investment is $7,546,869; its NPV is $887,887
- A Project’s IRR will “INCREASE” if the projects cash flow increases, and everything else is unaffected
Calculation of Initial Investment
The Project’s Internal Rate of Return [IRR] is the rate at which the Present Value of the annual cash flows is equals to the total Initial Investment. Here, We has the IRR as 13.80%, Using this we calculate the Initial Investment of the Project which is equals to the total Present Value of Annual cash Inflows.
Year
Annual Cash Inflows
Present Value factor at 13.80%
Present Value of Annual cash Inflows
1
$1,600,000
0.878734622
$1,405,975
2
$3,000,000
0.772174536
$2,316,524
3
$3,000,000
0.678536499
$2,035,609
4
$3,000,000
0.596253514
$1,788,761
$7,546,869
Therefore, Initial Investment = $7,546,869
Calculation of NPV at 9%
Year
Annual Cash Inflows
Present Value factor at 9%
Present Value of Annual cash Inflows
1
$1,600,000
0.917431193
$1,467,890
2
$3,000,000
0.841679993
$2,525,040
3
$3,000,000
0.77218348
$2,316,550
4
$3,000,000
0.708425211
$2,125,276
$8,434,756
Net Present Value [NPV] = Present Value of cash Inflows – Initial Investment
= $8,434,756 - 7,546,869
= $887,887
Year
Annual Cash Inflows
Present Value factor at 13.80%
Present Value of Annual cash Inflows
1
$1,600,000
0.878734622
$1,405,975
2
$3,000,000
0.772174536
$2,316,524
3
$3,000,000
0.678536499
$2,035,609
4
$3,000,000
0.596253514
$1,788,761
$7,546,869
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.