Question

Modern Federal Bank is setting up a brand-new branch. The cost of the project will be $1.2 million. The branch will create additional cash flows of $235,000, $412,300, $665,000 and $875,000 over the next four years. The firm's cost of capital is 12 percent. What is the internal rate of return on this branch expansion? (Do not round intermediate computations. Round final answer to the nearest percent.)

A) 20%
B) 23%
C) 25%
D) 27%

Answer 1

The correct answer is C. The internal rate of return on this branch expansion is approximately 23%.

Step-by-step explanation:

To calculate the internal rate of return (IRR), we need to find the discount rate at which the present value of the cash inflows equals the initial investment.

Using the formula for present value of an annuity, we calculate:

Initial investment = $1.2 million

Present value of cash inflows = $235,000/(1+0.12) + $412,300/(1+0.12)^2 + $665,000/(1+0.12)^3 + $875,000/(1+0.12)^4

IRR is the discount rate that makes the present value of cash inflows equal to the initial investment. We can use the IRR function in Excel or financial calculator to find the rate, which is approximately 23%. Therefore, the internal rate of return on this branch expansion is approximately 23%.