The net present value (NPV) and internal rate of return (IRR) methods of investm

Question

The net present value (NPV) and internal rate of return (IRR) methods of investment analysis are interrelated and are sometimes used together to make capital budgeting decisions. Consider this case: Last Tuesday, Green Caterpillar Garden Supplies Inc. lost a portion of its planning and financial data when its server and its backup server crashed. The companys CFO remembers that the internal rate of return (IRR) of Project Delta is 11.3%, but he cant recall how much Green Caterpillar originally invested in the project nor the projects net present value (NPV). However, he found a note that contained the annual net cash flows expected to be generated by Project Delta. They are: The CFO has asked you to compute Project Deltas initial investment using the information currently available to you. He has offered the following suggestions and observations: A projects IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows equals the discounted value of its cash outflows-when the cash flows are discounted using the projects IRR. The level of risk exhibited by Project Delta is the same as that exhibited by the companys average project, which means that Project Deltas net cash flows can be discounted using Green Caterpillars 8% WACC. Given the data and hints, Project Deltas initial investment is and its NPV is rounded to the nearest whole dollar).

Explanation / Answer

At IRR, Present value of Cash inflow = Present value of cash outflow.

Firstly calculate Present value of cash infow using IRR of 11.3 %

2,400,000

0.898

So, The Project Delta's initial investment = $ 11983200 (At IRR of 11.3 %).

Now we will calculate NPV.

NPV = Present value of cash inflow - Present value of cash outflow.

Present value of cash infow @ 8 % given in the question is calculated below:-

So, The NPV is 12959400 - 11983200 = $976200 Answer.

Year Cash infow Present value Factor at the end of each year @ 11.3 % ( [Taken up to three digits after point (.) ] Present value 1

2,400,000

0.898

2155200 2 4,500,000 0.807 3631500 3 4,500,000 0.725 3262500 4 4,500,000 0.652 2934000 Present value of cash inflow 11983200

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