Assume that a company is considering an investment project that will require an
ID: 2656538 • Letter: A
Question
Assume that a company is considering an investment project that will require an additional investment of $2,000,000. This project has a four-year life. The Weighted Average Cost of Capital for this company is 10%. The cash flows that this project is expected to return to the company are as follows:
-Year 1: $650,000
-Year 2: $760,000
-Year 3: $780,000
-Year 4: $850,000
Find the Internal Rate of Return (IRR) and the Net Present Value (NPV) of this project. Make the decision whether to invest or not. Please show your work and explain your decision regarding investing.
Explanation / Answer
NPV = $385,595.25
IRR = 18.24%
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Decision:
NPV is positive hence we should invest. The present value of cash flows is giving more returns than WACC or discount rate of the firm.
IRR is more than WACC or discount rate means we should invest. IRR should be more than targeted WACC.
WORKING:
NPV = $385,595.25
Discount rate = R =
10.00%
Present Values (PV)
Year
Cash flows
Discount factor or PV factors = Df = 1/(1+R)^Year
PV of cash flows = Cash flows x Df
0
-$2,000,000.00
1.000000
-$2,000,000.00
1
$650,000.00
0.909091
$590,909.09
2
$760,000.00
0.826446
$628,099.17
3
$780,000.00
0.751315
$586,025.54
4
$850,000.00
0.683013
$580,561.44
Total of PV = NPV =
$385,595.25
IRR = 18.24% ; IRR is obtained from trial and error method we have to fix such rate for discount that it forces NPV = 0 or sum of all cash flows equal to zero
Discount rate = R =
18.24%
Present Values
Year
Cash flows
Discount factor or PV factors = Df = 1/(1+R)^Year
PV of cash flows = Cash flows x Df
0
-$2,000,000.00
1.000000
-$2,000,000.00
1
$650,000.00
0.845728
$549,723.06
2
$760,000.00
0.715255
$543,594.17
3
$780,000.00
0.604911
$471,830.92
4
$850,000.00
0.511590
$434,851.85
Total of Present values = NPV =
$0.00
Discount rate = R =
10.00%
Present Values (PV)
Year
Cash flows
Discount factor or PV factors = Df = 1/(1+R)^Year
PV of cash flows = Cash flows x Df
0
-$2,000,000.00
1.000000
-$2,000,000.00
1
$650,000.00
0.909091
$590,909.09
2
$760,000.00
0.826446
$628,099.17
3
$780,000.00
0.751315
$586,025.54
4
$850,000.00
0.683013
$580,561.44
Total of PV = NPV =
$385,595.25
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