cash flow All cash flows will occur in Erewhon and are expressed in dollars. In
ID: 2737266 • Letter: C
Question
cash flow
All cash flows will occur in Erewhon and are expressed in dollars. In an attempt to improve its economy, the Erewhonian government has declared that all cash flows created by a foreign company are “blocked” and must be reinvested with the government for one year. The reinvestment rate for these funds is 4 percent.
If Anderson uses an 11 percent required return on this project, what are the NPV and IRR of the project?
Find
NPV
yearcash flow
0 -1,250,000 1 425,000 2 490,000 3 385,000 4 340,000Explanation / Answer
1
First, we need to find the future value of the cash flows for the one year in which they are blocked by the government. So, reinvesting each cash inflow for one year, we find:
Computation of NPV:
Year
Cash flow
PV Factor @ 11%
PV
0
$ (1,250,000)
1
$ (1,250,000)
1
0
0.9009
$ -
2
$ 454,750
0.8116
$ 369,085
3
$ 524,300
0.7312
$ 383,364
4
$ 411,950
0.6587
$ 271,364
5
$ 363,800
0.5935
$ 215,898
NPV
$ (10,289)
Computation of IRR
Let us try with 10%
Year
Cashfow
PV Factor @ 10%
PV
0
$ (1,250,000)
1
$ (1,250,000)
1
0
0.9091
$ -
2
$ 454,750
0.8264
$ 375,826
3
$ 524,300
0.7513
$ 393,914
4
$ 411,950
0.6830
$ 281,367
5
$ 363,800
0.6209
$ 225,891
NPV1
$ 26,999
As NPV is positive let us try with 11%
Year
Cashfow
PV Factor @ 11%
PV
0
$ (1,250,000)
1
$ (1,250,000)
1
0
0.9009
$ -
2
$ 454,750
0.8116
$ 369,085
3
$ 524,300
0.7312
$ 383,364
4
$ 411,950
0.6587
$ 271,364
5
$ 363,800
0.5935
$ 215,898
NPV2
$ (10,289)
IRR= R1 + NPV1(R2-R1)/{NPV1-(-NPV2)
=10% + 26,999(11-10)%(26,999-(-10,289)
=10% +269.99/37,289
=10% +0.72%
=10.72%
Year
Cash flow
PV Factor @ 11%
PV
0
$ (1,250,000)
1
$ (1,250,000)
1
0
0.9009
$ -
2
$ 454,750
0.8116
$ 369,085
3
$ 524,300
0.7312
$ 383,364
4
$ 411,950
0.6587
$ 271,364
5
$ 363,800
0.5935
$ 215,898
NPV
$ (10,289)
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