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Finding IRR
A company is considering the purchase of a piece of equipment costing $120,000 that would save
$30,000 each year for five years. The equipment could be sold at the end of its useful life for $15,000. The
company requires every project to yield a return of 10% or more otherwise they will be rejected. Should
this equipment be purchasedANS:-
Annual depreciation will be :- (120-15)/5=21000Step 1 says “Calculate the first NPV, using a rate that is two-thirds of the return on investment.
The return on investment would be -(30000-21000)/(0.5*(120000+15000))=13.3%.Two-thirds of this is 8.9% and so we can start by trying 9%.My question is why multiply the Investment outflows in denominator by 0.5 and the for the rates to used in IRR is 2/3 of 13.3%=9%
I do not have the BPP Study Text (only the Revision Kit).
The rule you quote in step 1 is completely unnecessary and would be ridiculous to apply in the exam.
You need to make two ‘guesses’ when asked to calculate the IRR, but for the exam any two guesses are fine. As I explain in my free lectures, different guesses will give a slightly different answer (because the relationship is not linear) but this is irrelevant in the exam.
I do suggest that you watch my free lectures on this (and if necessary the relevant Paper MA (was F2) lectures, because this is revision of Paper MA).
The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.But why the Calculation of ROI is such like that in the book????
we know ROI = Net profit / Cost of investment.
In general sense, here the cost of investment is 120000.But in this math, why does cost of investment includes disposal price (i.e 120000+15000) and why its multiplied by 0.5?
Is it a wrong calculation in BPP text? ??
This has absolutely nothing to do with the question originally posted.
The original question was not asking about the ROI but about the IRR, and there is no connection whatsoever between them. ROI is not examined in Paper AFM.
You have posted about this question in the Paper PM forum also and I have replied to you there.
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