Davis Chili Company is considering an investment of $35,000, which produces the

Question

Davis Chili Company is considering an investment of $35,000, which produces the following inflows:

Year

1

2

3

Cash Flow

16000

15000

12000

You are going to use the net present value profile to approximate the value for the internal rate of return. Please follow these steps:

a. Determine the new present value of the project based on a 10 percent discount rate.

b. Determine the net present value of the project based on a 10 percent discount rate.

c. Determine the net present value of the project based on a 15 percent discount rate (it will be negative).

d. Draw a net value profile for the investment and observe the discount rate at which the net present value is zero. This is an approximation of the internal rate of return based on the procedure presented in this chapter.

Explanation / Answer

a) New present value of the project = 16000/(1+10%) + 15000/(1+10%)^2 + 12000/(1+10%)^3

New present value of the project = $ 35957.93

b. Determine the net present value of the project based on a 10 percent discount rate.

Net present value of the project = 35957.93 - 35000

Net present value of the project = 957.93

c. Determine the net present value of the project based on a 15 percent discount rate (it will be negative).

Net present value of the project = -35000 + 16000/(1+15%) + 15000/(1+15%)^2 + 12000/(1+15%)^3

Net present value of the project = - $ 1854.61

d. Draw a net value profile for the investment and observe the discount rate at which the net present value is zero. This is an approximation of the internal rate of return based on the procedure presented in this chapter.

IRR = (0-957.93)*(15%-10%) / (-1854.61 - 957.93) + 10%

IRR = 11.70% approx

Note :

Exact IRR = irr({-35000,16000,15000,12000})

Exact IRR = 11.62%

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