Answer to Question #117933 in Finance for jiten shreshtha

Question #117933
Find internal rate of return for the project whose cash flows are as flows: 8
Initial investment = Rs.5,00,000
Annual benefit = Rs. 1,50,000
Annual cost = Rs.30,000
Salvage value = Rs. 40,000
MARR = 12% per year
1
Expert's answer
2020-06-11T09:23:24-0400

Computing Internal rate of return using trial and error method;

steps;

  • Compute Net present value of the project using an arbitrary selected discount rate.
  • If the NPV so calculated is positive then try a higher rate and if negative try a lower rate.
  • Continue the process until the NPV is equal to zero.
  • Use linear interpolation to determine the exact rate

Formulas to be applied are as below,



where

r -rate of return

n -period in years

Rl-lower rate of return

Rh-higher rate of return

NPVh-Net present value using higher rate of return

NPVl-Net present value using lower rate of return


We select arbitrary discount rate, say 20.5% Assuming 10 year of usage.

since year one to year nine cash flows are in annuity,we first calculate NPV for the annuity as follows;




we then calculate present value for the 10th year,







NPV using a rate of 20.5% is 874,since it is positive but not large we can try a closer higher rate

remember our target is to have NPV at zero

Lets try 20.6, we apply the same concept as above





NPV using a rate of 20.6% is 848

since we have two rate which are close to zero we can use formula 3 above to calculate the exact IRR










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