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Internal rate of return and NPV

(a) A capital investment requiring one initial cash outflow is forecast to operating profits (cash) as follows

Year 1 $74,000
Year 2 $84,000
Year 3 $96,000
Year 4 $70,000

The investment has an NPV of $20,850 based on a required rate of return of 12%. Calculate the payback period of the investment.

(b) The initial investment and expected profits (cash) from 2 mutually exclusive capital investments being considered by a firm are as follows:
Investment A Investment B
Initial Investment 70,000 65,000
Year 1 profit 30,000 50,000
Year 2 profit 80,000 50,000

(i) Calculate the internal rate of return for each investment. Which one would be selected based on an IRR ranking?
(ii) Which investment should be chosen if the firm's cost of capital is 14% (support your answer)?
(iii) Which investment should be chosen if the firm's cost of capital is 17% (support your answer)?

Solution Preview

A capital investment requiring one initial cash outflow is forecast to operating profits (cash) as follows

Year 1 $74,000
Year 2 $84,000
Year 3 $96,000
Year 4 $70,000

The investment has an NPV of $20,850 based on a required rate of return of 12%. Calculate the payback period of the investment.

NPV= Present value of inflows- Initial investment outlay

Present value of Inflows- NPV= Initial investment outlay

Thus Present value of inflow=

Year Cash Flow Present value Factor Present ...

Solution Summary

This shows how to compute Internal rate of return NPV and payback supported by examples

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