A new manufacturing device costs $10,000 to buy, but produces annual benefits of $3250 in reduced...
A new manufacturing device costs $10,000 to buy, but produces annual benefits of $3250 in reduced production costs. The device will operate for 4 years, at which time it will have no resale value. What is the internal rate of return on this investment?
Homework Answers
Initial cost = 10,000
Annual Benefits = 3,250
Life = 4 years
Calculate the internal rate of return.
Calculating the internal rate of return using the trial and error method
Let the rate of interest is 11%. Calculate the PW of the investment at 11%.
PW = -10,000 + 3,250 (P/A, 11%, 4)
PW = -10,000 + 3,250 (3.10245) = 83
The PW is positive. So increase the rate of interest to get negative PW.
Increase the rate of interest to 12% and calculate the PW at 12%.
PW = -10,000 + 3,250 (P/A, 12%, 4)
PW = -10,000 + 3,250 (3.03735) = -129
Using interpolation,
IRR = 11% + [83 – 0 ÷ 83 – (-129)] * 1
IRR = 11.39%
The internal rate of return will be 11.39%.
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