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Hi Sir
As I review the annuity and perpetuity chapter I often find questions I cant do.
Please help..
A company is considering an investment project that has a life of 4 years and requires an initial investment of 800,000. Net cash flows are estimated to be 281,000 per year. the project has a positive net present value of 53.397 when discounted at 12% per annum. ignore tax and inflation.. calculate the maximum discount rate at which the project will be financially viable…
I started to use IRR- but then was not sure which discount factor to use…
When calculating the IRR is does not matter what interest rates you use for your two guesses.
However here, because it is an annuity, you do not need to make two guesses.
The annuity factor must be (800,000 + 53,397) / 281,000.
Then you can use the annuity discount tables to see what rate of interest gives a 4 year factor equal to the above.
why must the annuity factor be (800,000+53,397)/281,000
which is the (initial investment +NPV)/net cash flows. Is that a formula I should remember?I did the above (800,000+53,397)/281,000= 3.037. I went to the annuity table and looked for a what rate of interest gives a 4 year factor equal to the above… and I get 12%. but the answer is 15%
have I done anything wrong?
Sorry, my mistake. The PV of the inflows is only 53,397 when using a discount factor of 12%.
So there is no ‘quick’ way.
You do need to make a second guess and calculate the NPV at (say) 20% (but any rate you want) and then approximate between them in the normal way to calculate the IRR.
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