Question

Problem 2. (15 Pts) Julian Stewart invested $280,000 in a limited partnership to drill for natural gas. The investment yielded annual returns of $45,000 the 1st yr, followed by $10,000 increases until the 6th yr, at which time an additional $180,000 had to be invested for deeper drilling. Following the 2nd drilling, the annual returns decreased by $10,000 per year, from $85,000 to $5,000. Using Excel, the IRR = 15.28%. a)Plot future worth as a function of MARR and. b)Plot future worth as a function of MARR • (MARR ranges from -50% to +50% increment by 5%) c)Determine the MARR that maximizes FW

Answer 1

Julian stewart invested $280000 in a limited partnership to drill for natural gas. The investment yielded annual returns of $45000 the Ist yr, followed by $10,000 increases until the 6th yr, at which time an additional $ 180,000 had to be invested for deeper drilling. Following the 2nd drilling, the annual returns decreased by $ 10000 per year, From $85000 to $ 5000. Using Excel IRR = 15.28%. Plot future worth as a function of MARR..

Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability   investments. Internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows . IRR calculations rely on the same formula as NPV does.

IRR = Internal rate of return = i*

• Interest rate at which the PW of cash flow equals 0.
• ROR of the cash flow under consideration.
• True rate of return.

The following is the formula for calculating NPV:

C_t = net cash inflow during the period t

C_o= total initial investment costs

r = discount rate, and

t = number of time periods

MARR = Minimum attractive rate of return

• Rate set by an organization to designate lowest level of 'i' that makes a cash flow option acceptable.
• The rate of return available to investor, should they choose to invest funds elsewhere rather than in the current proposal.
• Target ROR or Required ROR.

  IRR>MARR for a profitable venture.

Use i = MARR for CB_j>0      (Positivecash balance)
Use i = IRR (estimate) for CB_j<0      (Negative cash balance)

Use Trial and error with IRR guesses to get CB_N=0. Since at N with i* CB_N=0.
MARR is applied to (+) cash balances as if they were being invested at MARR for that year