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ACB co is appraising a project with an initial investment of $1 million that will generate net cash inflows after tax of $150, 000 per annum indefinitely. ACB co estimates its cost of capital at 12%.
What is ACB’s percentage sensitivity to their estimate of a 12% cost of capital?
3%
15%
25%
20%When i follow their workings i understand how the answer is 25%. However when i do my own workings the way i usually do it it does not come out right.
The way i do it is as follows, please show me where i am going wrong:(1/12%*150000)-1000000= 250000
using 20% to compare:
(1/20%*150000)-1000000=-250000IRR=
12%+ (250000/500000*8%)=16%(16%-12%)/12%=33.3%
????
You have calculated the IRR by making two ‘guesses’. That is what we usually do, but making two guesses only ever gives an approximate answer because the relationship is not linear.
Here, because it is a perpetuity, you do not need to make two guesses because you can calculate the IRR precisely.
It is exactly 150,000/1,000,000 = 15%, and therefore the sensitivity is indeed 25%.
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