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A machine has an investment cost of $60,000 at time 0. The present values (at time 0) of the expected net cash inflows from the machine over its useful life are:
Discount rate Present value of cash inflows
10% $64,600
15% $58,200
20% $52,100
What is the internal rate of return (IRR) of the machine investment?
A Below 10%
B Between 10% and 15%
C Between 15% and 20%
D Over 20%I think that the answer is D. but answer is B in book.
This is calculation:
Investment (60,000)
PV of cash inflow 64,600
NPV @ 10% $4,600Investment (60,000)
PV of cash inflow 58,200
NPV @ 15% (1,800)
The IRR of the machine investment is therefore between 10% and 15% because the NPV falls from $4,600 at 10% to –$1,800 at 15%. Therefore at some point between 10% and 15% the NPV = 0. When the NPV = 0, the internal rate of return is reached.I cannot guess why NPV are these figures. Can you give me some further explanation? Thank you in advance.
The question says that the figures given are the present value of the cash inflows, and so they do not take account of the initial investment of 60,000.
So the NPV at 10% is 64600 – 60000 = 4600
The NPV at 15% is 58200 – 60000 = (1800)The IRR is (by definition) the rate of interest at which the NPV is zero and this must therefore be between 10% and 15%.
I do suggest that you watch my free lectures on this. The lectures are a complete free course for Paper F2 and cover everything needed to be able to pass the exam well.
No – it is not given, and you do not need a formula anyway if you understand what is happening.
Do watch my free lectures on this – once you understand it then there is nothing to learn 🙂
The lectures are a complete free course for Paper F2 and cover everything needed to be able to pass the exam well.
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