Question

Your factory has been offered a contract to produce a part for a new printer. The contract would last for three years, and your cash flows from the contract would be $4.98 million per year. Your upfront setup costs to be ready to produce the part would be $8.07 million. Your discount rate for this contract is 8.4% a. What is the IRR? b. The NPV is $4.67 million, which is positive so the NPV rule says to accept the project. Does the IRR rule agree with the NPV rule? a. What is the IRR? The IRR is %. (Round to two decimal places.)

Can someone please help with this question. THANK YOU!

Answer 1

a)

IRR is the rate of return that makes initial investment equal to present value of cash inflows

8,07,000 = 4,980,000 / (1 + R)¹ + 4,980,000 / (1 + R)⁴ + 4,980,000 / (1 + R)³

Using trial and error method, i.e after trying various values for R, lets try R as 38.46%

8,07,000 = 4,980,000 / (1 + 0.3846)¹ + 4,980,000 / (1 + 0.3846)⁴ + 4,980,000 / (1 + 0.3846)³

8,07,000 = 8,07,000

Therefore, IRR is 38.46%

c)

A project should be accepted when IRR is greater than cost of capital. A positive NPV will always have an IRR greater than cost of capital. Here the IRR is greater than 8.4%. Therefore, it agrees with NPV rule