Question

Oriole, Inc., a resort management company, is refurbishing one of its hotels at a cost of $7,488,051. Management expects that this will lead to additional cash flows of $1,725,000 for each of the next six years. What is the IRR of this project? If the appropriate cost of capital is 12 percent, should Oriole go ahead with this project? (Round answer to 4 decimal places, e.g. 5.2516\%.) The IRR of this project is % The firm should he project.

Answer 1

The IRR of the project is approximately 18.53%. Oriole should go ahead with this project as the cost of capital is lower than the IRR.

Step-by-step explanation:

To calculate the Internal Rate of Return (IRR) of a project, we need to determine the discount rate at which the present value of expected cash inflows equals the initial investment. In this case, the initial investment is $7,488,051 and the expected cash flows are $1,725,000 per year for six years. The IRR is the rate at which the Net Present Value (NPV) of the project is zero.

Using the formula NPV = -Initial Investment + (Cash Flow / (1 + Discount Rate) ^ Year), we can calculate:

0 = -7,488,051 + (1,725,000 / (1 + IRR) ^ 1) + (1,725,000 / (1 + IRR) ^ 2) + ... + (1,725,000 / (1 + IRR) ^ 6)

By trial and error, we find that the IRR of this project is approximately 18.53%.

Since the appropriate cost of capital is 12%, which is lower than the IRR of the project, Oriole should go ahead with this project. It is expected to generate a positive return and is therefore financially viable.