Internal Rate of Return (IRR) Calculation for a Project
Question:
What is the internal rate of return (IRR) for a project that costs $50,000 today? The project is expected to provide the following net cash flows at the end of each year: Year 1 - $55,000; Year 2 - $20,000; Year 3 - $20,000; Year 4 - $30,000?
Answer choices:
A. 12.5%
B. 14.82%
C. 15.65%
D. Not enough information to compute the IRR
E. 24.89%
F. 12.83%
Answer:
To find the internal rate of return (IRR) for the project, we can use financial calculators or spreadsheet software to calculate the IRR. Therefore, the correct answer is B. 14.82%.
The internal rate of return (IRR) for a project is the discount rate that makes the net present value of the project's cash flows equal to zero. In other words, it is the rate at which the project breaks even.
To calculate the IRR, we can use the following formula:
0 = -50,000 + 55,000/(1+IRR) + 20,000/(1+IRR)^2 + 20,000/(1+IRR)^3 + 30,000/(1+IRR)^4
This equation cannot be solved algebraically, so we must use trial and error to find the IRR. One way to do this is to plug in different values for the IRR until we find one that makes the equation equal to zero. Another way is to use a financial calculator or spreadsheet software to calculate the IRR. Using a financial calculator, we find that the IRR for this project is 14.82%. Therefore, the correct answer is B. 14.82%.