Consider two streams of cash flows, A and B . Stream A ’s first cash flow is $10

Question

Consider two streams of cash flows, A and B . Stream A ’s first cash flow is $10,400 and is received three years from today. Future cash flows in Stream A grow by 3 percent in perpetuity. Stream B ’s first cash flow is $9,300, is received two years from today, and will continue in perpetuity. Assume that the appropriate discount rate is 11 percent.

Suppose that the two streams are combined into one project, called C. What is the IRR of Project C?

Consider two streams of cash flows, A and B . Stream A ’s first cash flow is $10,400 and is received three years from today. Future cash flows in Stream A grow by 3 percent in perpetuity. Stream B ’s first cash flow is $9,300, is received two years from today, and will continue in perpetuity. Assume that the appropriate discount rate is 11 percent.

Suppose that the two streams are combined into one project, called C. What is the IRR of Project C?

Explanation / Answer

If we combine the cash flows of both the streams, we get:

Year       Cash flow

1             

2              -9300

3              10400

4              10400 x1.03 =10712 and It will continue increasing by 3%every year till infinity

IRR of growing perpetuity

Initial outflow = fist inflow/ (irr – g)

    9300 = 10,400/(irr-0.03)

9300 irr = 10,400 +279

                Irr = 10679/9300

                      = 114.83%

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