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    Internal rate of return using interpolation

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    Elgin Restaurant Supplies is analyzing the purchase of manufacturing equipment that will cost $20,000. The annual cash inflow for the next three years will be:

    Year cash flow

    1 $10,000
    2 9,000
    3 6,500

    a. Determine the internal rate of return using interpolation.
    b. With a cost of capital of 12 percent, should the machine be purchased?

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    Solution Preview

    a. Determine the internal rate of return using interpolation.

    IRR is the rate at which the NPV=0. In the interpolation method, we find the NPV at different rates till we get one NPV as positive and one NPV as negative. This would imply that IRR would be in-between these rates since at IRR the NPV=0. We then interpolate to find the IRR.
    We choose any ...

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