Hosier and Wogan (H&W) is a partnership that owns a small company. It is conside

Question

Hosier and Wogan (H&W) is a partnership that owns a small company. It is considering two alternative investment opportunities. The first investment opportunity will have a five-year useful life, will cost $9,840.48, and will generate expected cash inflows of $2,400 per year. The second investment is expected to have a useful life of three years, will cost $6,442.74, and will generate expected cash inflows of $2,500 per year. Assume that H&W has the funds available to accept only one of the opportunities. (PV of $1 and PVA of $1).

a.

Internal Rate of Return

First Investment

___%

Second Investment

___%

Calculate the internal rate of return of each investment opportunity.

Internal Rate of Return

First Investment

___%

Second Investment

___%

Explanation / Answer

The formula for IRR is:

0 = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n

where P0, P1, . . . Pn equals the cash flows in periods 1, 2, . . . n, respectively; and
IRR equals the project's internal rate of return.

A general rule of thumb is that the IRR value cannot be derived analytically. Instead, IRR must be found by using mathematical trial-and-error to derive the appropriate rate. However, most business calculators and spreadsheet programs will automatically perform this function.

1 option Year 0 -9840.48 1 2400 2 2400 3 2400 4 2400 5 2400 IRR 7.0% option 2 Year 0 -6442.74 1 2500 2 2500 3 2500 IRR 8.0%

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