3 investments compared over a ten year study period. only invest if you can earn
ID: 2649409 • Letter: 3
Question
3 investments compared over a ten year study period. only invest if you can earn more than 8% interest (nominal)
1) intial cost 50000 earn 12000 yearly OandM cost is 4600/ year
2)750000 initial net earnings 175000 and then an OandMcost of 60000 / year
this option has an IRR(internal rate of return) of 8.64%
3) 2000 intital 350 earning yearly and cost of 50 a year
Compute the IRR for the first option to 1/100th of a percent
if the projects are independent which ones should you invest in?
if the projects are exclusive and you have to choose which should you invest in (based on the IRR)
Explanation / Answer
Answer No. 1
Compute the IRR for the first option to 1/100th of a percent
IRR is discount rate that makes the net present value of all cash flows from a particular project equal to zero. To find out IRR We have to assume various discount rate by trial and error method.
Suppose discount rate is 7.8466%
Year
Cash outflow
Cash inflow
Net cash flow
Disc rate - 7.85%
present value
A
B
C
D
C*D
A+B
0
-50000
0
-50000
1.00
-50000
1
-4600
12000
7400
0.93
6862
2
-4600
12000
7400
0.86
6362
3
-4600
12000
7400
0.80
5899
4
-4600
12000
7400
0.74
5470
5
-4600
12000
7400
0.69
5072
6
-4600
12000
7400
0.64
4703
7
-4600
12000
7400
0.59
4361
8
-4600
12000
7400
0.55
4044
9
-4600
12000
7400
0.51
3750
10
-4600
12000
7400
0.47
3477
IRR
7.8466%
NPV
0.0
Answer : So IRR of project 1 is 7.85% (Approx)
Answer No. 2
if the projects are independent which ones should you invest in?
3 investments compared over a ten year study period. only invest if you can earn more than 8% interest (nominal).
So cost of capital is 8%.
Project 1
Year
Cash outflow
Cash inflow
Net cashflow
Disc Rate - 8%
Net cashflow
A
B
C
D
C*D
A+B
0
-50000
0
-50000
1.00
-50000
1
-4600
12000
7400
0.93
6851.85
2
-4600
12000
7400
0.86
6344.31
3
-4600
12000
7400
0.79
5874.36
4
-4600
12000
7400
0.74
5439.22
5
-4600
12000
7400
0.68
5036.32
6
-4600
12000
7400
0.63
4663.26
7
-4600
12000
7400
0.58
4317.83
8
-4600
12000
7400
0.54
3997.99
9
-4600
12000
7400
0.50
3701.84
10
-4600
12000
7400
0.46
3427.63
NPV
-345.40
Project 2
Year
Cash outflow
Cash inflow
Net cashflow
Disc Rate - 8%
Net cashflow
A
B
C
D
C*D
A+B
0
-750000
0
-750000
1.00
-750000
1
-60000
175000
115000
0.93
106481.48
2
-60000
175000
115000
0.86
98593.96
3
-60000
175000
115000
0.79
91290.71
4
-60000
175000
115000
0.74
84528.43
5
-60000
175000
115000
0.68
78267.07
6
-60000
175000
115000
0.63
72469.51
7
-60000
175000
115000
0.58
67101.40
8
-60000
175000
115000
0.54
62130.92
9
-60000
175000
115000
0.50
57528.63
10
-60000
175000
115000
0.46
53267.25
NPV
21659.36
Project 3
Year
Cash outflow
Cash inflow
Net cashflow
Disc Rate - 8%
Net cashflow
A
B
C
D
C*D
A+B
0
-2000
0
-2000
1.00
-2000
1
-50
350
300
0.93
277.78
2
-50
350
300
0.86
257.20
3
-50
350
300
0.79
238.15
4
-50
350
300
0.74
220.51
5
-50
350
300
0.68
204.17
6
-50
350
300
0.63
189.05
7
-50
350
300
0.58
175.05
8
-50
350
300
0.54
162.08
9
-50
350
300
0.50
150.07
10
-50
350
300
0.46
138.96
NPV
13.02
Answer : NPV of Project 2 and Project 3 is positive. So Project 2 and Project 3 should be accepted.
Answer 3
if the projects are exclusive and you have to choose which should you invest in (based on the IRR)
IRR is discount rate that makes the net present value of all cash flows from a particular project equal to zero. To find out IRR We have to assume various discount rate by trial and error method.
Project 1
Suppose discount rate is 7.85%
Year
Cash outflow
Cash inflow
Net cash flow
A
B
C
A+B
0
-50000
0
-50000
1
-4600
12000
7400
2
-4600
12000
7400
3
-4600
12000
7400
4
-4600
12000
7400
5
-4600
12000
7400
6
-4600
12000
7400
7
-4600
12000
7400
8
-4600
12000
7400
9
-4600
12000
7400
10
-4600
12000
7400
IRR
7.85%
Project 2
Suppose discount rate is 8.64%
Year
Cash outflow
Cash inflow
Net cashflow
A
B
C
A+B
0
-750000
0
-750000
1
-60000
175000
115000
2
-60000
175000
115000
3
-60000
175000
115000
4
-60000
175000
115000
5
-60000
175000
115000
6
-60000
175000
115000
7
-60000
175000
115000
8
-60000
175000
115000
9
-60000
175000
115000
10
-60000
175000
115000
IRR
8.64%
Project 3
Suppose discount rate is 8.14%
Year
Cash outflow
Cash inflow
Net cash flow
A
B
C
A+B
0
-2000
0
-2000
1
-50
350
300
2
-50
350
300
3
-50
350
300
4
-50
350
300
5
-50
350
300
6
-50
350
300
7
-50
350
300
8
-50
350
300
9
-50
350
300
10
-50
350
300
IRR
8.14%
Answer : if the projects are exclusive , based on the IRR we should invest in project 2 because project 2 has highest IRR of 8.64% among all three projects.
Year
Cash outflow
Cash inflow
Net cash flow
Disc rate - 7.85%
present value
A
B
C
D
C*D
A+B
0
-50000
0
-50000
1.00
-50000
1
-4600
12000
7400
0.93
6862
2
-4600
12000
7400
0.86
6362
3
-4600
12000
7400
0.80
5899
4
-4600
12000
7400
0.74
5470
5
-4600
12000
7400
0.69
5072
6
-4600
12000
7400
0.64
4703
7
-4600
12000
7400
0.59
4361
8
-4600
12000
7400
0.55
4044
9
-4600
12000
7400
0.51
3750
10
-4600
12000
7400
0.47
3477
IRR
7.8466%
NPV
0.0
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.