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12 January, 03:49

Cutler Petroleum, Inc., is trying to evaluate a generation project with the following cash flows:Year Cash Flow0 - $ 39,800,000 1 63,800,000 2 - 12,800,000 This project has two IRR's, namely percent and percent, in order from smallest to largest. (Note: If you can only compute one IRR value, you should input that amount into both answer boxes in order to obtain some credit.)

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  1. 12 January, 04:05
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    The two IRRs are: - 76.49% and 36.79%

    Explanation:

    To simplify our "Hard work", let's denote the cash flow numbers in terms of '000 (To reduce the number of zeros).

    IRR is that discount rate R, for which NPV = 0

    NPV is the sum of discounted cash inflows and outflows. Therefore,

    NPV ($'000) = - 39,800 + (63,800 / (1 + R) - [12,800 / (1 + R) 2]

    When NPV = 0 [If R is the IRR],

    0 = - 39,800 + [ (63,800 / (1 + R) ] - [12,800 / (1 + R) 2]

    [12,800 / (1 + R) 2] - [ (63,800 / (1 + R) ] + 39,800 = 0

    To simplify further, let's put N = 1 + R. Also, let's divide both sides by 200 [Note: We're only doing arithmetical simplification to reduce the large numbers]]:

    [64 / (N) 2] - (319 / N) + 199 = 0

    Multiplying all terms by (N2):

    64 - 319N + 199 (N) 2 = 0

    that is,

    199 (N) 2 - 319N + 64 = 0

    This is a quadratic equation with large coefficients. Solving quadratic equation is outside scope of this question (it belongs to Algebra), so I've used an Online Quadratic equation solver**, which returns following values of N:

    N = 1.3679, and N = 0.2351

    So:

    1 + R = 1.3679, Or 1 + R = 0.2351

    R = (1.3679 - 1) or R = (0.2351 - 1)

    R = 0.3679 or R = - 0.7649

    The two IRRs are: - 76.49% and 36.79%
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