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279 An education authority is considering the implementation of a CCTV (closed circuit
television) security system in one of its schools. Details of the proposed project are as
follows:
Life of project 5 years
Initial cost $75,000
Annual savings:
Labour costs $20,000
Other costs $5,000
NPV at 15% $8,800
What is the internal rate of return for this project?
A 16%
B 18%
C 20%
D 22%Please do not simply type out full questions and expect to be provided with a full answer. You must have an answer in the same book in which you found the question, and so in future ask about whatever it is in the answer that you are not clear about. Then I will explain.
You need to calculate the NPV at a higher rate than 15% (I would choose 20%), and then approximate between 15 and 20% to find the rate of interest that gives an NPV of zero.
I explain how to do this in my free lectures on investment appraisal. The lectures are a complete free course for Paper MA and cover everything needed to be able to pass the exam well.
Sir I’m facing some confusion in such questions, could you please elaborate why did you chose 20%? Because during exam how are we supposed to know which one would give the opposite answer, like in this positive NPV 15% gives us $8,800, so we need the one which gives us a small negative value, while 20% gives us that, but how? Is there any logic behind this?
Have you watched my free lectures on this? Because I explain about choose the rates in the lectures.
If 20% were to give a positive value then from the choices given it would obviously mean that the IRR was 22%.
Yes sir i watched your lecture on this topic, i.r.r, NPV all of them. But i still face confusion that how are we going to make a random guess, like it says npv at 15% is $8,800, and that is positive npv, and for irr we need 2 values, one positive and one negative to calculate irr, and so I’m wondering why did you chose 20%? In exam how are we going to know 20% is going to give us a negative npv? What if i choose 16 or any other? And if it doesn’t provides with the negative npv, i would just waste time figuring out negative npv 🙁
We do not need 20% to give a negative NPV. As I wrote in my previous reply then if 20% had given a positive receipt it would mean that of the choices available the IRR could only possibly be 22%.
The IRR must be one of the four choices given in the question. 16% is obviously very unlikely to be the answer given the NPV at 15%. So choose any of the other three as your second guess. However most sensible would be to choose either 18% or 20%.
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