Question

A firm evaluates all of its projects by applying the IRR rule. The required return for thefollowing project is 21 percent. The IRR is _____ percent and the firm should ______ theproject.Year Cash Flow0 -$28,6431 $21,0002 $16,0003 $4,000

Answer 1

Answer:

The IRR is 26.3

The project should be accepted

Explanation:

Period Cash Flow

0 -28643.0

1 21000.00

2 16000.00

3 4000.00

IRR 0.26299326 = 26.30

The IRR is the rate at which the net present value is zero

$-28,643 + \frac{21,000}{1+IRR} + \frac{16,000}{(1+IRR)^{2}}+ \frac{4,000}{(1+IRR)^{3} } = 0$

It is calculate with trial an error.

using a financial calculator.

or excel.

for example we calculate with rate 0.26

$-28,643 + \frac{21,000}{1+0.26} + \frac{16,000}{(1+0.26)^{2}}+ \frac{4,000}{(1+0.26)^{3} }$

NPV = 101.40

and rate 0.27

$-28,643 + \frac{21,000}{1+0.27} + \frac{16,000}{(1+0.27)^{2}}+ \frac{4,000}{(1+0.27)^{3} }$

NPV = -234.79

at 26 the NPV is positive

at 27 negative, so the IRR is vbetween those two values.

once we have this, we start moving whit the decimals

26.1

26.2

26.3

until we are close enough

In this case at 26.3

$-28,643 + \frac{21,000}{1+0.263} + \frac{16,000}{(1+0.263)^{2}}+ \frac{4,000}{(1+0.263)^{3} }$

NPV = -0.23

we are close enought on a project of thousands of dollars we are missing for cents.