I learned this from a different book which says: where both first and second NPV are positive or negative then you use extrapolation and
where NPV are in set of positive and negative whole numbers we use interpolation.
Is this true? if so
An investment project has net present values as follows:
Discount rate 11% per annum: net present value $35,170 positive
Discount rate 15% per annum: net present value $6,040 positive.
What is the best estimate of the internal rate of return?
In Bpp book it is solved by doing Interpolation method giving 15.8% (C). While it should have been done by Extrapolation giving 6.2% because both rates have + NPV.
Please help thanks.
True, but that is a technical difference. The standard formula for estimation IRR works whether both are + or both – or one of each.
Both NPVs are positive and are reducing as discount rate increases. At 15% we have not yet gone negative so IRR must be above 15%.
IRR = 11 + 35,170 X (15 – 11)/ (35,170 – 6,040) = 15.8 (B)
Covered on P139 of our notes.
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