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Hi,
I came across this question in practice exam kit Q256.
What I do not understand is why would the discount rate reduce, the NPV would become zero. Isn’t that the lower the discount rate, the better (higher) the NPV? the higher the discount rate, the lower the NPV?Thanks,
Q256
Q Co is going to invest in a new piece of machinery that will cost $8,000,000. The discount
rate of the project is 15% and the PV of the tax shield is $100,000.
What is the IRR? Give your answer as a % to 2 decimal places
_____________%Answer: 14.81
The IRR is the discount rate where the NPV falls to zero.
It is a really a sensitivity calculation, the questions we need to ask ourselves are as follows:
(1) How much would the NPV need to change by? 100,000
(2) What is this as a % of the investment? 100,000/8,000,000 × 100 = 1.25%
So if the discount rate reduced by 1.25% the NPV would fall to zero.
IRR = 15% × 98.75% = 14.8125
Answer: 14.81I don’t understand the question at all!
We have no information about the cash inflows at all so do not know either it’s NPV or APV ($100,000 higher than NPV). If we do not know inflows, we cannot calculate the IRR.
I suggest you put a line through it and waste no more time on it.
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