Share
Explore BrainMass

Internal rate of return

I already have the answer (k*=25.91%) to this problem from my text book but I need to know step by step how they got to the answer. All that is provided in the example is:

Price = NOI1/(1+K*)^1 + NOI2/(1+K*)2........+ (NOI5 + Residual)/(1+k*)^5

where K* = expected before-tax return on an unlevered investment
NOI= Net Operating Income in period i (i=1, 2,....5)
Residual = Net Selling Price

Comparable "A"

$96,428 = $13,500/(1+K*)^1 + $12,555/(1+K*)^2+$12,931.65/(1+K*)^3+$13,966.18/(1+K*)^4

+$208,079.14/(1+K*)^5

k*=25.91%

Solution Preview

The equation is
$96,428 = $13,500/(1+K*)^1 + $12,555/(1+K*)^2+$12,931.65/(1+K*)^3+$13,966.18/(1+K*)^4

+$208,079.14/(1+K*)^5

K* is called the discounting factor. If you manually want to do it, then it is the trial and error method. If we did not know the answer, we start with say 15%. We get
$13,500/(1+15%)^1 + $12,555/(1+15%)^2+$12,931.65/(1+15%)^3+$13,966.18/(1+15%)^4 ...

Solution Summary

The solution explains how to calculate the IRR using trial and error

$2.19