Thorley Inc. is considering a project that has the following cash flow data. Wha

Question

Thorley Inc. is considering a project that has the following cash flow data.  What is the project's IRR?  Note that a project's IRR can be less than the WACC or negative, in both cases it will be rejected.

Year     0          1          2          3          4          5

Cash flows -$1,075        $325    $325    $325    $325    $325

Thorley Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the WACC or negative, in both cases it will be rejected.

Explanation / Answer

IRR stands for Internal Rate of Return. It is an interest rate. In your example, the IRR is the interest rate that makes having $1,075 RIGHT NOW the same as getting $325 every period and putting it into a savings account to collect interest. The lower (or higher) the IRR the more (or less) money you need RIGHT NOW.

For the above project, the IRR is the interest rate that satisfies he following equation:

1,075= 325/(1+irr) + 325/(1+irr)^2 + 325/(1+irr)^3 + 325/(1+irr)^4 + 325/(1+irr)^5.

Using a financial calculator, the IRR can be calculated I used Business Smarts at www.maxigrade.com as a reference.

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