SHOW ALL STEPS AND USE EQUATIONS A company said it plans to spend $20.7 million
ID: 1216479 • Letter: S
Question
SHOW ALL STEPS AND USE EQUATIONS
A company said it plans to spend $20.7 million in expanding its fiber-optic Internet and television network. It will make the company more competitive than other TV providers and will generate net annual revenue of $4.35 million per year. And the salvage value will be $3 million after the 15 year project life.
a) Determine the IRR for the company. Please use interpolation.
b) If the company requires at least a 10% return on its investments, should the company carry out the investment? Why?
Explanation / Answer
(a)
Working note:
In year 15, Net Revenue will increase by $3 million of salvage value, to $(4.35 + 3) = $7.35 million.
Using approximation method,
IRR = RL + [NPVL / (NPVL - NPVH)] x (RH - RL) where
RH: Higher interest rate = 12% (assumed),
RL: Lower interest rate = 6% (assumed)
NPVH: NPV at higher rate
NPVL: NPV at lower rate
So, IRR = 6% + [22.8 / (22.8 - 9.48)] x (12 - 6)%
= 6% + (22.8 / 13.32) x 6%
= 6% + 1.71 x 6%
= 6% + 10.26%
= 16.26%
(b) Since IRR > Required return of 10%, company should carry out the investment.
Year Cash Flow($ Million) Discount factor @6% Discounted Cash Flow: @6% Discount factor @12% Discounted Cash Flow: @12% (A) (B) (A) x (B) (D) (A) x (D) 0 -20.70 1.0000 -20.70 1.0000 -20.70 1 4.35 0.9434 4.10 0.8929 3.88 2 4.35 0.8900 3.87 0.7972 3.47 3 4.35 0.8396 3.65 0.7118 3.10 4 4.35 0.7921 3.45 0.6355 2.76 5 4.35 0.7473 3.25 0.5674 2.47 6 4.35 0.7050 3.07 0.5066 2.20 7 4.35 0.6651 2.89 0.4523 1.97 8 4.35 0.6274 2.73 0.4039 1.76 9 4.35 0.5919 2.57 0.3606 1.57 10 4.35 0.5584 2.43 0.3220 1.40 11 4.35 0.5268 2.29 0.2875 1.25 12 4.35 0.4970 2.16 0.2567 1.12 13 4.35 0.4688 2.04 0.2292 1.00 14 4.35 0.4423 1.92 0.2046 0.89 15 7.35 0.4173 3.07 0.1827 1.34 NPV = 22.80 NPV = 9.48Related Questions
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