IRR Mock exam question 18 — OpenTuition Forums

ZZuzie11y ago

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 $20 The 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, Zuzie

John MoffatTutor11y ago#1

I 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%.

ZZuzie11y ago#2

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

John MoffatTutor11y ago#3

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.)

ZZuzie11y ago#4

:) Thank you

John MoffatTutor11y ago#5

You are welcome :-)