Consider the following cash flows: Year Cash Flow 0 ($33,000) 1 $14,500 2 $17,20

Question

Consider the following cash flows: Year Cash Flow 0 ($33,000) 1 $14,500 2 $17,200 3 $11,900 The NPV at a discount rate of zero percent is $10,100 The NPV at a discount rate of 9 percent is $3,468 The NPV at a discount rate of 19 percent is ($2,107) The NPV at a discount rate of 29 percent is ($6,380) What happens as the required return increases? Is it better to have a higher or lower required return? Why? Consider the following cash flows: Year Cash Flow 0 ($33,000) 1 $14,500 2 $17,200 3 $11,900 The NPV at a discount rate of zero percent is $10,100 The NPV at a discount rate of 9 percent is $3,468 The NPV at a discount rate of 19 percent is ($2,107) The NPV at a discount rate of 29 percent is ($6,380) What happens as the required return increases? Is it better to have a higher or lower required return? Why?

Explanation / Answer

IRR of the project is the rate at which the NPV of the project is zero i.e. at this rate the present value of inflows and outflows is equal. In the instant case, IRR is 16% so if required rate of return increases beyond IRR than the NPV of the project will be negative. Hence though higher the required rate of return is better it should not be more than IRR otherwise the project will start generating negative NPV

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