Anderson International Limited is evaluating a project in Er

Anderson International Limited is evaluating a project in Erewhon. The project will create the following cash flows:

Year Cash Flow

0 –$ 1,190,000

1 365,000

2 430,000

3 325,000

4 280,000

All cash flows will occur in Erewhon and are expressed in dollars. In an attempt to improve its economy, the Erewhonian government has declared that all cash flows created by a foreign company are “blocked” and must be reinvested with the government for one year. The reinvestment rate for these funds is 5 percent. If Anderson uses a required return of 9 percent on this project, what are the NPV and IRR of the project?

Solution

NPV :

  year cash flow PVF (_9%,4year) present value

  0 -1190000 1 -1190000

  1 365000 0.917 334705

   2 430000 0.842 362060

3 325000 0.772 250900

4 280000 0.708 198240

- $ 44095

IRR :

year cash flow weight cash flow * weight

  1 365000 4 1460000

   2 430000 3 1290000

3 325000 2 650000

4 280000 1 280000

10 3680000

step 1 weight average = 3680000 / 10 = $368000

step 2 approximate IRR = $1190000 / 368000 = 3.234

step 3 search the value for nearest to 3.234 in 4years row of PVAF = 8% and 9%

year cash flow PVF (_9%,4year)    PVF (_10%,4year)    PV @9% PV@10%

  1 365000 0.917 0.909 334705 331785

   2 430000 0.842 0.826   362060 355180

3 325000 0.772 0.751    250900 244075

4 280000 0.708 0.683 198240    191240

$ 1145905 $1122280

At 9% NPV = $ 1145905 - $ 1190000 = $-44095

At 10% NPV = $ 1122280 - $ 1190000 = $- 67720

IRR = 9% + (1122280 - 1190000 / 1122280- 1145905 * (9-10)

= 9 % + (-67720 / - 23625 * -1)

= 9 % - 2.87%

= 6.13%