Answer:
4.25%
Explanation:
We need to calculate the net present value of the cash flows to determine the IRR.
NPV = PV of Cash inflows - PV of Cash outflows
As the cash inflow and outflow are fixed for specific period of time so, we will use the annuity formula to calculate the NPV.
NPV = [ $5,000 x ( 1 - ( 1 + 18% )^-5) /18% ] - [ ( $4,000 x ( 1 - ( 1 + 18% )^-12) /18%) x ( 1 + 18%)^-6 ]
NPV = $15,636 - $7,102 = $8,534
We need NPV on a higher rate of 10%
NPV = [ $5,000 x ( 1 - ( 1 + 10% )^-5) /10% ] - [ ( $4,000 x ( 1 - ( 1 + 10% )^-12) /10%) x ( 1 + 10%)^-6 ]
NPV = $18,954 - $15,385 = $3,569
IRR = Lower rate + [ Lower rate NPV / (Lower rate NPV - Higher rate NPV) ] (higher rate - lower rate)
IRR = 10% + [ 3,569 / ($3,569 - $8,534) ] (18% - 10%)
IRR = 4.25%
