Answer:
C. between 14% and 15%
Explanation:
IRR (internal rate of return) is the rate whereas the net present value (NPV) of project is zero.
We can easily calculate IRR in excel by the formula = IRR(-720000,230000,370000,360000) = 14.73%
However, this exercise want you to do the calculation manually, so we have to do as followings:
- calculate NPV of each year cash inflow with every present value of $1 according to every discount rate
- The sum up of all NPV of 3 years cash inflow with the initial investment
- Any sum up nearest to zero, then the applied rate is the IRR
For example 1: we do for rate 14%
NPV of Cash inflow Year 1 = 230,000*0.877= 201.710
NPV of Cash inflow Year 2 = 370,000*0.769= 284,530
NPV of Cash inflow Year 3 = 360,000*0.675= 243,000
So NPV of investment = 201.710 + 284,530 +243,000 – 720,000= 9,240
For example 2: we do for rate 15%
NPV of Cash inflow Year 1 = 230,000*0.870= 200,100
NPV of Cash inflow Year 2 = 370,000*0.756= 279,720
NPV of Cash inflow Year 3 = 360,000*0.658= 238,880
So NPV of investment = 200,100+ 279,720 + 238,880 – 720,000= (3,300)
The NPV of investment turn from $9,240 to (3,300) when rate change from 14% to 15%; thus IRR is between 14% and 15%
