Question

Boulderado has come up with a new composite snowboard. Development will take Boulderado four years and cost $250,000 per year, with the first of the four equal investments payable today upon acceptance of the project. Once in production the snowboard is expected to produce annual cash flows of $200,000 each year for 10 years. Boulderado's discount rate is 10%. The IRR for boulderado's snow board project is closest to :
A. 10.4%

B.10.0%

C.11.0%

D.15.1%

Answer 1

Answer:

The answer is C: 11%

Workings for NPVs are attached.

Explanation:

What Is Internal Rate of Return – IRR?

The internal rate of return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments. The internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. IRR calculations rely on the same formula as NPV does.

Tip:

To calculate the IRR we need to perform a hit and trial method - rule of thumb is, use the discount factor, that give one positive and one negative NPV, suppose, if 10% discount factor gives a positive NPV, we should choose the second discount factor that is above 10%, so the cost of investment will be high and thus giving us a negative NPV.

IRR calculations:

Key metrix used:

Discount factor (rₐ) = 10% (lowest discount factor)

NPV at lowest discount factor = 51,608

Discount factor (rb) = 15% (highest discount factor)

NPV at highest discount factor = - 161,000

IRR Formula:

IRR Formula = rₐ +$\frac{NPVa}{NPVa - NPVb}$ × (rb - ra)

IRR Formula = 10% + $\frac{51,608}{51,608 - (-161,000)}$ × (15% - 10%)

IRR Formula = 11%