Purchase Solution

Calculating NPV, IRR and incremental IRR

Not what you're looking for?

Ask Custom Question

1. Front up cost of plant is $100 million. Profits of $30million at the end of every year. Calculate the NPV if the cost of capital is 8%. Should you take the investment? Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.

2. Upfront costs $5 million. Profits expected $1million for 10 yrs. The company will provide support expected to cost $100,000/year in perpetuity. Assume all profits and expenses occur at end of year.

a. What is the NPV if cost of capital is 6%? Should firm take project? Repeat for discount rates of 2% and 12%.
b. How many IRRs does this investment opportunity have?
c. Can the IRR rule be used to evaluate this investment? Explain

3.Please choose between 2 projects:

Year end Cash Flow ($thousands)
Project 0 1 2 IRR
Playhouse -30 15 20 10.4%
Fort -80 39 52 8.6%

You can undertake only one project. If your cost of capital is 8% use the incremental IRR rule to make the correct decision.

Purchase this Solution

Solution Summary

There are three problems. Solutions to these problems depict the methodology to calculate NPV, IRR and incremental IRR.

Solution Preview

Please refer attached file for better clarity of tables and graphs.

1.
Discount rate=r=8%
Annual Cash inflow=C=$30
PV of perpetuity =C/r=30/8%=$375 million
But this is value at the end of year 1,

PV of cash inflows=375/(1+8%)=$347.22 million
PV of outflows=$100

NPV of project=PV of inflows-PV of outflows=347.22-100=$247.22 million.
It is positive value, it should be accepted.

Now calculate IRR
At IRR, NPV=0 i.e. PV of cash inflows=PV of cash outflows
So, PV of Inflows=PV of cash outflows=$100

Let IRR=r
PV of inflows=(30/r)/(1+r)
(30/r)/(1+r)=100
30/[r*(1+r)]=100
30=100r+100r^2
10r^2+10r-3=0
r=(-10+sqrt(10^2-4*10*-3))/(2*10)=0.2416

Internal rate of return=24.16%

If the cost of capital estimate is off by 16.16% (24.16%-8%), then the decision might change from accept to reject.

2.

Year End Cash Outflow Cash Inflow Net Cash flow PV of cash Flows at (PV=C/(1+r)^n)
(n) C ...

Solution provided by:
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
Recent Feedback
  • "Thank you"
  • "Really great step by step solution"
  • "I had tried another service before Brain Mass and they pale in comparison. This was perfect."
  • "Thanks Again! This is totally a great service!"
  • "Thank you so much for your help!"
Purchase this Solution


Free BrainMass Quizzes
Organizational Leadership Quiz

This quiz prepares a person to do well when it comes to studying organizational leadership in their studies.

Employee Orientation

Test your knowledge of employee orientation with this fun and informative quiz. This quiz is meant for beginner and advanced students as well as professionals already working in the HR field.

Six Sigma for Process Improvement

A high level understanding of Six Sigma and what it is all about. This just gives you a glimpse of Six Sigma which entails more in-depth knowledge of processes and techniques.

MS Word 2010-Tricky Features

These questions are based on features of the previous word versions that were easy to figure out, but now seem more hidden to me.

Paradigms and Frameworks of Management Research

This quiz evaluates your understanding of the paradigm-based and epistimological frameworks of research. It is intended for advanced students.