Butler International Limited is evaluating a project in Erewhon. The project wil

Question

Butler International Limited is evaluating a project in Erewhon. The project will create the following cash flows: Year Cash Flow 0 –$ 950,000 1 285,000 2 345,000 3 415,000 4 255,000 All cash flows will occur in Erewhon and are expressed in dollars. In an attempt to improve its economy, the Erewhonian government has declared that all cash flows created by a foreign company are “blocked” and must be reinvested with the government for one year. The reinvestment rate for these funds is 4 percent. If Butler uses a required return of 11 percent on this project, what are the NPV and IRR of the project?

Explanation / Answer

Let IRR = r

Then at IRR = r, NPV = 0

     0 = (-)950,000 + (296,400 / (1+r)2) + (358,800 / (1+r)3) + (431,600 / (1+r)4) + (265,200 / (1+r)5)

     at r = 10%, NPV = 23,987.37

     at r = 11%, NPV = (-) 5,352.40

        IRR = 10% +(23,987.37) / (23,987.37 - (-) 5,352.40) x 1

              = 10.82%

Period Cash Flows ($)               Cash Flows After Reinvestment Present Value Factor @ 11% Present Value ($) 0 (950,000) (950,000) 1 (950,000.00) 1 285,000 285,000 x 1.04 = 296,400 0.812 240,676.80 2 345,000 345,000 x 1.04 = 358,800 0.731 262,282.80 3 415,000 415,000 x 1.04 = 431,600 0.659 284,424.40 4 255,000 255,000 x 1.04 = 265,200 0.593 157,263.60 NPV (-)5,352.40

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