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29 January, 14:58

A project that provides annual cash flows of $24,000 for 9 years costs $110,000 today. Under the IRR decision rule, is this a good project if the required return is 8 percent?

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  1. 29 January, 15:04
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    IRR (22%) is greater than the required rate of return of 8%, so we accept te project for implementation.

    The project is good.

    Explanation:

    The IRR is the discount rate that equates the present value of cash inflows to that of cash outflows. At the IRR, the Net Present Value (NPV) of a project is equal to zero

    If the IRR greater than the required rate of return, we accept the project for implementation

    If the IRR is less than that the required rate, we reject the project for implementation

    Lets calculate the IRR

    Step 1: Use the given discount rate of 8% and work out the NPV

    NPV = 24,000 * (1 - (1.08) ^ (-9)) / 0.08) - 110,000

    = (24,000 * 6.2468) - 110,000

    = 39,925.31

    Step 2 : Use discount rate of 40% and work out the NPV (40% is a trial figure)

    NPV = 24,000 * (1 - (1.4) ^ (-9) / 0.4) - 110,000

    = (24,000 * 2.3789) - 110,000

    = (52,904.02)

    Step 3: calculate IRR

    = 8% + ((39,925.31 / (39,925.31+52,904.02)) * (40%-8%)

    = 22%

    Step 4 : compare the IRR (22%) to 8% and make decision

    IRR (22%) is greater than the required rate of return of 8%, so we accept the project for implementation.

    That is the project is good.
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