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In BBP Text, it is written
“The ARR is $409 x $2,000 = 20%. We take two-thirds of the ARR (approximately 14%) to find an initial estimate of the IRR. The initial estimate of the IRR that we shall try is therefore 14%.”
I don’t understand why to try discount rate with 2/3 of ARR.I cannot comment without seeing the actual question, but in any normal situation it does not matter what guesses you use to be able to estimate the IRR and there is no logic at all in using the ARR as a basis for an estimate.
This is the quiestion:
Find the IRR of the project given below and state whether the project should be accepted if the
company requires a minimum return of 17%.
Time $
0 Investment (4,000)
1 Receipts 1,200
2 ” 1,410
3 ” 1,875
4 ” 1,150I want to know how ARR can be used to estimate the discount rate of the project.
As I wrote before, there is no logic at all in using the ARR to estimate a discount rate.
You make two guesses – any guesses – and estimate the IRR in the normal way.
I do suggest you watch my lectures on this.
So why do we need to calculate the ARR first in this question? Can’t we calculate the IRR directly.
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