Homework Answers
Ans. Cashflow in year 0, CF0 = -Initial Investment
For A1 = -$500000
For A2 = -$800000
For A3 = -$300000
Cash flow in year 1 to 10, CF1 to CF10 = Annual revenue
For A1 = $100000
For A2 = $140000
For A3 = $70000
Internal rate of return (r) is the interest rate at which net present worth (NPV) of the cash flow is zero
Thus, NPV = 0 = CF0 + CF1/(1+r) + CF2/(1+r)^2 + CF3/(1+r)^3 + CF4/(1+r)^4 + CF5/(1+r)^5 + CF6/(1+r)^6 + CF7/(1+r)^7 + CF8/(1+r)^8 + CF9/(1+r)^9 + CF10/(1+r)^10
Thus, using the above formula,
Rate of return of A1 = 15.098%
Rate of return of A2 = 11.725%
Rate of return of A3 = 19.357%
Thus, with highest rate of return of 19.357%, Alternative A3 is the best alternative.
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