Question

Your firm has been hired to develop new software for the​ university's class registration system. Under the​ contract, you will receive $ 505 comma 000 as an upfront payment. You expect the development costs to be $ 434 comma 000 per year for the next 3 years. Once the new system is in​ place, you will receive a final payment of $ 837 comma 000 from the university 4 years from now. a. What are the IRRs of this​ opportunity?  ​ (Hint: Build an Excel model which tests the NPV at​ 1% intervals from​ 1% to​ 40%. Then zero in on the rates at which the NPV changes​ signs.) b. If your cost of capital is 10 %​, is the opportunity​ attractive? Suppose you are able to renegotiate the terms of the contract so that your final payment in year 4 will be $ 1.2 million.   c. What is the IRR of the opportunity​ now? d. Is it attractive at the new​ terms?

Answer 1

a)

Please refer to below spreadsheet for calculations and answers.

Formula reference -

Thus, IRR of this project is 8.72%

b)

If opportunity cost is 10%

Project having IRR less than the opportunity cost are not preferable because at IRR NPV is Zero and any rate above IRR force NPV to negative side.

If we check NPV of project at 10% opportunity cost in above spreadsheet , we will get NPV at 10% is ($2,611.50) which is negative.

Thus, if opportunity cost is 10% then This opportunity is not attractive.

c)

If Final payment in 4th year is $ 1,200,000

Lets first calculate the NPV at 10%

Formula reference -

NPV at 10% is $ 245,322, Thus, if final payment increased to $ 1.2 millions in 4th year then Opportunity is attractive.