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Good Day Sir
Please assist with the following:
Using an interest rate of 10% per year the NPV=$50
If the interest rate is increased by 1% the NPV of the project falls by $20The text provides an answer of 12.5% but I get 10.6% even though are calculation methods are identical:
0.10 +((50/80)x0.01))=10.6%
Is there something I am missing?
Regards,
ZuzieI have no idea where your 80 comes from!
For a NPV of zero, we need the NPV to fall by 50.
If a fall of 20 is an increase in interest rate of 1%, the a fall of 50 needs an increase in interest rate of 50/20 x 1% = 2.5%.
Since at 50, the interest is 10%. For an NPV of zero, the interest rate must be 10% + 2.5% = 12.5%.
Good Day Sir
I use the formula as it’s the best way I understand it:
IRR=L+(NL/(NL-NH)(H-L)
=0.10+(50/50+30)(0.11-.10)
=0.10+.625(.01)
=.10625
=10.6%I am using 30 as the question stated that NPV fell by $20
I am sorry, but I never use a formula. The formula is not given in the exam – the danger is forgetting it in the exam, and also (as in this question) although it will work it can cause confusion.
Also, the exam questions are designed in such a way as to check that you understand what is happening as opposed to just having learned rules.
(If you insist on using a formula, then NL-NH = 50-20. You have written 50+20.)
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