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  • 1.  Part 2 Investment Decision -IRR calculation

    Posted 05-27-2020 10:07 PM
    Bears, Inc. is considering investing in testing equipment to improve the quality control of its products. The
    new equipment will cost $983,000, with an estimated useful life of four years and no salvage value.
    Management has set a minimum return of 15% for similar investment opportunities. The new equipment is
    expected to generate $365,900 in after-tax operating expense savings, but will require a working capital
    commitment of $40,000 for the entire four years of the investment life (four years). What is the equipment's
    expected internal rate of return?

    A 18.1%
    B 19.1%
    C 16%
    D 17.1% Correct

    Can someone help me to understand the IRR Calculation

    Thanks

    ------------------------------
    Aaditya
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  • 2.  RE: Part 2 Investment Decision -IRR calculation

    Posted 05-31-2020 02:57 AM
    Hi Aadtiya
    Here is answer I worked out for this problem
    Bears Inc - Cash flow Statement   Useful Life 4 years
    Cash Flow From Investment     Cash Flow Type
    Year 0 Asset Purchase ($983,000) Outflow
    Year0 Working Capital Committed ($40,000) Outflow
           
        ($1,023,000) Total Outflow from Investment
    Cash flow from Operations      
           
    Cash flow From Operations (after Tax)    $      365,000 Inflow
         $    365,000 Total Outflow from Operations
           
           
    Cash Flow From disposal      
      Salvage value   $               -   None
      Woring Capital Release  $   40,000.00 Inflow
         $       40,000 Total Inflow from Disposal


        1 2 3 4
            Hurdle Rate 15%
      Initial Outlay
    Period 0    		 Period 1 Period 2 Period 3 Period 4
      ($1,023,000) 365,000 365,000 365,000 405,000
               
    IRR 17.0%        
               
    NPV $41,937        
               
    DCF 2.80 Years ($658,000) ($293,000) $72,000  
      Periods 1 2 ($0.80)  

    I used Excel IRR and NPV function so there could be rounding off issues that the answer is not exactly 17.1% for IRR. For exam purpose and practice we should use a good financial calculator.

    As regards the acceptability of the project, the NPV is postive and the IRR % is more than the hurdle rate marked by the firm hence the project can be accepted. In general the thumb rule is that when there is a conflict between IRR % and NPV, the NPV holds good for deciding the acceptability criteria of a project.

    Hope this helps

    Kind regards
    Srirama Subramanian.

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    Srirama Nagarajan
    Chennai
    India
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    Original Message


  • 3.  RE: Part 2 Investment Decision -IRR calculation

    Posted 05-31-2020 03:14 AM
    And there are small corrections:

    A) the Cash Flow from operations is not Out Flow, but an inflow (positive)
    B) the last year amount increase was due to Cash Inflow from Operations + WC release 

    Kind regards
    Srirama Subramanian

    ------------------------------
    Srirama Nagarajan
    Chennai
    India
    ------------------------------

    Original Message


  • 4.  RE: Part 2 Investment Decision -IRR calculation

    Posted 06-01-2020 07:17 AM
    Hi Srirama,

    How could calculate IRR?

    Cash flow is 365,900​/- in question and not 365,000/-

    I couldnt arrive at 17.1% with the the cash flow of 365,900/-

    Regards/Muralee
    Chennai

    ------------------------------
    Muraleedharan Thachangode
    Controller
    Chennai
    India
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    Original Message