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 $5.00 million per year. Your upfront setup costs to be ready to produce the part would be $8.00 million. Your discount rate for this contract is 8.0 %.

a. What is the​ IRR? The IRR is_____ %. (Round to two decimal​ places.)

b. The NPV is $4.89 ​million, which is positive so the NPV rule says to accept the project. Does the IRR rule agree with the NPV​ rule?______.

Answer 1

IRR is the rate at which NPV = 0

Let it be x

0 = 5*PVAF(x%,3 years) - 8

PVAF(x%, 3 years) = 1.6

PVAF(39%, 3 years) = 1.609

PVAF(40%, 3 years) = 1.589

Using interpolation, IRR = 39% + (1.609-1.6)/(1.609-1.589)

= 39.45%

b.Since IRR is more than discount rate, decision is to accept the project.

Hence, IRR rule agrees with the NPV rule