Question

QUESTION 2 Ahmad opened a Bike Repair Shop. He shared his net cash flow (NCF) figures for the 3 years, including the $17,000 amount that it took to get started in business. (a) Determine the rate of return value. Year Net Cash Flow, $ -17,000 20,000 -5,000 8000 oooo w

Answer 1

Answer) 24.4%

We need to calculate the Internal rate of return of the business

Internal rate of return is that rate which equates the net present value of cash inflows with the net present value of cash outflows.(i.e the net present value becomes zero).

Step 1: We would first take 20% and 25% as the base rates:

Year	NCF	DF (20%)	Present value	DF (25%)	Present value
0	-17,000	1	-17,000	1	-17,000
1	20,000	0.83	16,667	0.80	16,000
2	-5,000	0.69	-3,472	0.64	-3,200
3	8,000	0.58	4,630	0.51	4,096
			824		-104

Step 2: We would now use interpolation to arrive at the final rate

-The net present value at 20% is $824.

-The net present value at 25% is $-104.

-We need to calculate a rate wherein the net present value is $0.

Therefore,

The net present value falls by $1,757 [824-(-104)] with a 5% increase in the discounting rate.

Therefore, for the net present value to fall by $824 (To make it 0); the discounting rate should increase by:

=(824*10%)/928

=4.43% (apprx)

Therefore, the interest rate will be 20+4.43=24.43%(apprx)

=24.4%