Question

Maxwell Feed & Seed is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC (and even negative), in which case it will be rejected.

Answer 1

Answer:

13.31%

Explanation:

some information is missing:

Year        Cash flows

0              −$1,100

1                  $450

2                 $470

3                 $490

the easiest way to calculate the IRR is by using a financial calculator, IRR = 13.31%

but if we don't have one at hand, the IRR is the discount rate at which a project's NPV = 0

1,100 = 450/(1 + r) + 470/(1 + r)² + 490/(1 + r)³

to simplify the formula we must use trial and error:

since we already know the real IRR, I will start with a close number like 10%

1,100 = 450/(1 + 0.1) + 470/(1 + 0.1)² + 490/(1 + 0.1)³

1,100 = 409.09 + 388.43 + 368.14

1,100 ≠ 1,165.66

since the NPV is still positive, we must increase the discount rate. following the example we can use 12%

1,100 = 450/(1 + 0.12) + 470/(1 + 0.12)² + 490/(1 + 0.12)³

1,100 = 401.79 + 374.68 + 348.77

1,100 ≠ 1,125.24

we must increase the discount rate even more to 13%

1,100 = 450/(1 + 0.13) + 470/(1 + 0.13)² + 490/(1 + 0.13)³

1,100 = 398.23 + 368.08 + 339.59

1,100 ≠ 1,105.90

we keep increasing the discount rate to 14%

1,100 = 450/(1 + 0.14) + 470/(1 + 0.14)² + 490/(1 + 0.14)³

1,100 = 394.74 + 361.65 + 330.74

1,100 ≠ 1,087.13

since now the NPV is negative, the discount rate must be between 13-14%

we continue this way until we finally reach 13.31%