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Dear tutor,
in bpp revision kit answer to q18 “Slow Fashions Co” (6/09) part (a) it is said that IRR cannot be calculated on proportions of project. Why?
And in part b) we are asked to calculate max % rate that the co is ready to pay to finance investment in all the remaining projects. In answer it is said that IRR is irrelevant, because it results in NPV=O. Ok, I understand. Then it is said that the maximum cost of capital acceptable to the additional finance required is basic cost of cap+profitability index of projects rejected which equals 17.652%. I tried to discount cash flows of rejected projects at 17.652%, but it gave me negative NPV. So I can’t understand the meaning of this figure…
BPP’s answer is very poor.
In part (a)) I think they have been copying the examiners answer but missed part of what he wrote!!!!!!!
You certainly can calculate the IRR on proportions of projects, but there is no point because the IRR of (say) 50% of a projects flows will be the same as the IRR on the whole project flows, and we know what the IRR’s are.
What they should have said (and what the examiner effectively said) is the we can’t take a weighted average of the individual flows – that won’t work.
So we have to calculate the IRR of the whole ‘package’.With regard to part (b) what you are forgetting is that we are after the maximum rate worth paying for short-term finance. We only need the funding for one year (because in one year we can get more funding at our current cost of capital). So for that one year we are prepared to pay 17.652%. We certainly would not be prepared to pay that if it were long-term funding because (as you say) we would have a negative NPV.
Dear Sir
If we can calculate IRR for a portion of the project, then is IRR of choice 1 calculated this way?
Project Initial investment 2010 2011 2012 2013 2014 2015
PO805 -120 25 55 75 21
PO801 -620 280 400 120
PO802 (whole) -640 80 120 200 210 420 -30
PO802 (71.875%) -460 58 86 144 151 302 -22
Total -1,200 363 541 339 172 302 -22
IRR 14.5%thanks
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