Question

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?

Answer 1

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

The project is good.

Step-by-step 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.