You are negotiating to make a 7 year loan of $25,000 to breck inc. To repay you,

Question

You are negotiating to make a 7 year loan of $25,000 to breck inc. To repay you, Breck will pay $2,500 at the end of year 1, $5,000 at the end of year 2 and $7,500 at the end of year 3, plus a fixed but currently unspecified cash flow,X, at the end of each year from year 4 through year 7. Breck is essentially riskless, so you are confident the payments will be made. Your regard 8% as an appropriate rate of return on a low risk but illiquid 7 year loan. What cash flow must the investment provide at the end of each of the final 4 years, that is, what is X?

Explanation / Answer

The present value of cash inflows (payments) should equal the initial loan amount ($25,000). We use the IRR function to find rate of return that would make the NPV equal zero, and we use a bit of guessing. For each of the last 4 years we enter one of the choices until we find the choice that would make the IRR = 8% (The discount rate given in the problem). As per the calculations above, it turns out that the correct choice is c. $4,733.15

Year Cash Flow 0 ($25,000) 1 $2,500 2 $5,000 3 $7,500 4 $4,733.15 5 $4,733.15 6 $4,733.15 7 $4,733.15 IRR 8%

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.