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Dear tutor,
In SLOW FASHIONS( jun 09) , requirement b asked us to etimate the maximum interest rate to pay in all the remaining projects. Here I don’t understand why we can’t use IRR to estimate the additional interest rate. IRR is the rate to let projects’ NPV be zero, and the ansnwer is also to let the npv be zero.why we should use NPV(which is discounted at current DR)/the remaining investment to get the additional rate but not IRR??
Thanks in advance!!
I have the same understanding problem. I would be very grateful if somebody could answer Kateker’s session.
Sorry – I don’t know how I managed to miss Kateker’ question when it was first asked.
If the question simply asked for the IRR of the remaining projects then you would calculate it as normal. Just suppose it was 11% (I have invented that figure) – then it would mean that you would be prepared to pay up to 11% to do those projects.
However, that is not the case here. The cost of capital is 10% and is staying at 10%. The only reason that we are not doing the rejected projects is that we do not have enough capital this year. But the question says that we will have more capital next year – so next year we could afford to do them without problem (at a cost of 10%).
So……if we want to do them this year we will have to borrow the money just for one year (next year we can replace the borrowing with long-term capital at a cost of 10%).
If we could borrow for that one year at 10% then obviously we would do them. We can afford to pay more than 10% but it will only be for that one year.
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