Question

CEO McIntosh is considering an investment option: (20 points) Time Cash Flow A Year0 $-4000 Year 1 $-2000 Year 2 $2000 Year 3because the number does have a realistic interpretation. For the last rate (1.12), if he invests $1 at time 0, he would havePlease show work using formulas

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Answer #1

a) Withholding all the cash at the begining will result in changing the cash flow and thus the IRR. Cashflow will be as shown below and IRR will be 7.7% in such case.

Year 0 1 2 3 4 5
Cashflow -8000 0 2000 400 8000 0

For IRR calculation, refer to screenshot below

B) Investing the intial cash will help in getting higher return than 7.7%. This will add to cashflow in terms of interest

Year 0 1 2 3 4 5
Cashflow -8000 0 2000 400 8000 0
Interest (r%) 4000*r% (2000)*r% 2000*r% 2000*r% 2000*r%
Cash Invested 4000 2000 2000 2000 2000 (becomes 0 later)
Interest Earned 247.9 123.93 123.93 123.93 123.93
Net Cash Flow -8000 247.9 2123.93 523.93 8123.93 123.93

Through the use of solver if r=6.2% then IRR will be 10% (Values updated). This is based on assumption that the interest earned is withdrawn each year. If it does not and withdraws interest only at the end of the 5 years then investment rate needed shall be 6.7%

C) IRR of -1 or lesser is not possible as in that case we will be loosing the entire investment every year thus it will represent either a worst case liability scenario (shall be covered via insurance) or does not include complete time period of investment.

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