Question

Your company is buying a new product from a small company for $1 million dollars. You expect to make a profit of $250,000 per year from the product.

Required:
1. Given a MARR of 8%, what is the internal rate of return at three years and at six years?
2. Set up and solve the problem and then explain to management what your recommendation is for three and six years and why?

Answer 1

IRR at 3 years = -13.11

IRR at 6 years = 12.97

If the product would generate cash flows for only three years, the product shouldn't be bought because the IRR is negative and less than the MARR.

If the product would generate cash flows for 6 years, the product can be purchased because the IRR is postive and greater than the MARR

Step-by-step explanation:

The internal rate of return is the discount rate that equates the after tax cash flows from an investment to the amount invested.

The IRR can be calculated using a financial calculator:

Cash flow in year 0 = $-1,000,000

Cash flow each year from year one to three = $250,000

IRR = -13.11%

Cash flow each year from year one to six = $250,000

IRR = 12.97%

The IRR is negative and less than the MARR at three years so the product is unprofitable. The business shouldn't buy the product.

The IRR is postive and greater than the MARR at six years. The product is profitable and can be bought.

To find the IRR using a financial calacutor:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. After inputting all the cash flows, press the IRR button and then press the compute button.

I hope my answer helps you