Suppose your firm is considering investing in a project with the cash flows show
ID: 2737908 • Letter: S
Question
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 7 percent, and that the maximum allowable payback and discounted payback statistics for the project are 2.0 and 3.0 years, respectively.
Time/Cash Flow
0 –$6,800
1 $1,010
2 $2,210
3 $1,410
4 $1,410
5 $1,210
6 $1,010
Use the IRR decision rule to evaluate this project. (Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places.)
Use the IRR decision rule to evaluate this project. (Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places.)
Should it be accepted or rejected?
Explanation / Answer
All Amounts in $ The IRR or Internal Rate of Return is developed using the Trial-And-Error Method for calculating the rate of return on the project where the Net Cash Flows (Inflow-Outflow) is equal to 0. Since the required rate of return on projects of this class is 7%, using the Trial-And-Error Method, the IRR works out to 6.18% As the IRR is lower than the expected rate of return on the project, hence the same should be rejected.
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