711 Consider the following financial data for a project Init

7.11 Consider the following financial data for a project: Initial investment Project life Salvage value Annual revenue Annual expenses (including income taxes) $15,000 8 years $0 $9,229 $3,000 1

Solution

Working notes:

(1) Net income = Annual revenue - Annual expense

(2) i* (IRR) is that discount rate which makes NPV equal to zero and is found using approximation method as:

IRR = RL + [NPVL / (NPVL - NPVH)] x (RH - RL) where

RH: Higher interest rate = 12% (assumed),

RL: Lower interest rate = 6% (assumed)

NPVH: NPV at higher rate

NPVL: NPV at lower rate

Therefore,

(a)

So, IRR = 6% + [23,681 / (23,681 - 15,943)] x (12 - 6)% = 6% + (23,681 / 7,738) x 6%

= 6% + 3.06 x 6%

= 6% + 16.36%

= 22.36%

(b)

So, IRR = 6% + [18,907 / (18,907 - 12,483)] x (12 - 6)% = 6% + (18,907 / 6,424) x 6%

= 6% + 2.94 x 6%

= 6% + 17.66%

= 23.66%

	(A)	(B)	(C)=(B)-(A)	(D)	(C) x (D)	(E)	(C) x (E)
0	15,000		-15,000	1.0000	-15,000	1.0000	-15,000
1	3,000	9,229	6,229	0.9434	5,876	0.8929	5,562
2	3,000	9,229	6,229	0.8900	5,544	0.7972	4,966
3	3,000	9,229	6,229	0.8396	5,230	0.7118	4,434
4	3,000	9,229	6,229	0.7921	4,934	0.6355	3,959
5	3,000	9,229	6,229	0.7473	4,655	0.5674	3,535
6	3,000	9,229	6,229	0.7050	4,391	0.5066	3,156
7	3,000	9,229	6,229	0.6651	4,143	0.4523	2,818
8	3,000	9,229	6,229	0.6274	3,908	0.4039	2,516
				NPV =	23,681	NPV =	15,943