Alicia spends USD4100 per year in regular maintenance of the

Alicia spends USD4100 per year in regular maintenance of the roof of her house. Since she loses the job recently, she considers forgoing these maintenance expenses for the next 5 year. If she does so, it expects it will need to spend USD5000 in year 6 on repairing the roof.

Q1: What is the IRR of the decision to forgo maintenance of the roof?

A) 31%

B) 5 %

C) 50%

D) 41%

Q1.2: Does the IRR rule work for this decision?

A) Yes, we find a unique IRR which enables the NPV equal to zero

B) No, we are not sure whether there exist two IRR which can enable the NPV equal to zero

C) No, the IRR rule does not work in this case because we have no cost of capital to use as a comparison

D) Both B and C are correct

Solution

Computation of IRR Year 1 4100 2 4100 3 4100 4 4100 5 4100 6 -5000 a) IRR (calculated using excel) -43.61% =IRR(Cash flow from yr 1 to yr 6,40% as guess) b) Option C -No, the IRR rule does not work in this case because we have no cost of capital to use as a comparison