Suppose your firm is considering investing in a project with the cash flows show

Question

Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 11 percent, and that the maximum allowable payback and discounted payback statistics for your company are 2.5 and 3.0 years, respectively.
  
                     
Time:   0   1   2   3   4   5
Cash flow   –$234,000   $65,700   $83,900   $140,900   $121,900   $81,100

Use the IRR decision rule to evaluate this project. (Do not round intermediate calculations and round your final answer to 2 decimal places.)

IRR   %

Should it be accepted or rejected?

   Rejected
   Accepted

Explanation / Answer

Use the IRR decision rule to evaluate this project. (Do not round intermediate calculations and round your final answer to 2 decimal places.)

Using Excel Formula

IRR = irr(values)

IRR = irr({-234000,65700,83900,140900,121900,81100})

IRR = 28.94%

Should it be accepted or rejected?

Accepted

Note :

The Project should be accepted based on IRR i.e IRR is the 28.94% which is higher than cost of capital i.e 11%

The Project should be rejected if Payback period & Discounted payavback period is used since payaback period is 2.60 years which is higher than maximum allowable payback period is 2.50 Year and also discounted  payaback period is 3.05 years which is higher than maximum allowable discounted payback period is 3 Year

Working

Payback Period = 2 + 84400/140900 = 2.60 years

Discounted Payback Period = 3 + 3690.82/80299.31 = 3.05 Years

Year Cash Flow Cummulative of cash flow PV Factor @ 11% PV of Cash Flow Cummulative of PV of cash flow 0 -234000 -234000 1.00000          (234,000.00)                                            (234,000.00) 1 65700 -168300 0.90090              59,189.19                                            (174,810.81) 2 83900 -84400 0.81162              68,095.12                                            (106,715.69) 3 140900 56500 0.73119            103,024.87                                                (3,690.82) 4 121900 178400 0.65873              80,299.31                                                76,608.48 5 81100 259500 0.59345              48,128.90                                              124,737.39

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