Your project organization has to decide whether or not to invest in a project op

Question

Your project organization has to decide whether or not to invest in a project opportunity. The following information is available to you.
Initial cash outflow = $200,000 in the current year (year 0), and $50,000 in the next year
Cash inflows = $75,000 in year 1, $100,000 in year 2, $150,000 in year 3, and    $25,000 in year 4
Required rate of return = 15%
Inflation rate = 4%

Calculate the NPV for this project.

Calculate the IRR for this project.

Your project organization has to decide whether or not to invest in a project opportunity. The following information is available to you. Initial cash outflow = $200, 000 in the current year (year 0), and $50, 000 in the next year Cash inflows = $75,000 in year 1, $100, 000 in year 2, $150, 000 in year 3, and    $25,000 in year 4 Required rate of return = 15% Inflation rate = 4% Calculate the NPV for this project. Calculate the IRR for this project.

Explanation / Answer

The cash flows are summarized below:

We use MS Excel to calculate the NPV and IRR using the above data.

The cash flows are real while the expected payoff is nominal.

We first calculate the real discount factor:

r= 1.15/1.04 - 1 = 0.106 or 10.6%

NPV at 10.6% = NPV(0.106, B2:F2) = $69749.67

IRR = IRR(B2:F2) = 28%

Year 0 1 2 3 4 Cash Flow -200000 75000 100000 150000 25000

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