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Hi sir, Hope you are Well.
I was solving the questionin MCQ at opentution , the question no. was 4.I calculated NPV at 12% as per earlier question requirement( Q1 and 2 are have same data) . so, then for IRR i calculated at 15 % intrest rate. I got following values.
12% NPV = 33830
15% NPV = 15,420and the IRR comes to be – 12% + 33820/18410 x 5% = 21.19 % which is not in question.
I seen the solution and there the second npv value was calculated at 20 %. and npv value was in negative.
So, should i always calculate second npv at a intrest rate that the npv value will always negative ? Also, whats the logic behind that ?
I think you mean question 2 (not question 4).
Your workings are wrong, it should be 12% + ((33,820 / 18,410) x 3%) = 17.51% (which is 18% to the nearest %).
Any IRR calculated this way will only be approximate because the relationship is not linear. Having one positive and one negative NPV does give a better approximation but there is no need to waste time doing a third NPV in the exam (provided that you have not made ridiculous guesses. For example, because the NPV at 12% is so high, 13% would have been a silly guess 🙂 )
I do explain this in my free lectures. (The lectures are a complete free course for Paper MA and cover everything needed to be able to pass the exam well).
If you get a question like this, then the best to choose for the ‘second guess’ is the highest of the available answers (so in this case 20%). The reason is that unless 20% turns out to be the IRR (which is possible but unlikely) then the answer must end up being lower than 20% (because the other choices are less than 20%) and you will automatically have ended up with one +’ve and one -‘ve NPV 🙂
A machine has an investment cost of $60,000/- at time 0. The present value (at time 0) of the expected net cash inflows from the machine over its useful life are:
Discount rate. PV of cash inflows
10%. $64,600/-
15%. $58,200/-
20%. $52,100/-
What is the internal rate of return of the machine investment?
1) below 10%
2) between 10% and 15%
3) between 15% and 20%
4) over 20%Correct answer js between 10-15% (workings are for 10 to 15%)
My question is when i did workings for 15 and 20 % it shows me over 20% why is this answer not correct
I do not know what working you were doing, because not workings are needed!
At 10% the PV of the inflows is greater than the cost of $60,000 and therefore the NPV is positive.
At 15% the PV is less than the cost and therefore the NPV is negative.The IRR is when the NPV is zero, and so the IRR must be between 10% and 15%.
(At 20% the NPV is even more negative than at 15% and so the IRR cannot possibly be over 20%.)
Have you watched my free lectures on this? The lectures are a complete free course for Paper MA and cover everything needed to be able to pass the exam well.
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