Question

A small restaurant costs $350,000 Expected profits equal $22,000/year for 6 years when value is $400,000.

What is project’s rate of return?

Please show all steps.

Answer 1

Approximate Rate of return (ROR) is computed using interpolation method as follows.

ROR = RL + [NPVL / (NPVL - NPVH)] x (RH - RL) where

RL: Lower discount rate = 5% (assumed)

RH: Higher discount rate = 10% (assumed)

NPVL: NPV at 5%

NPVH: NPV at 10%

So

NPVL = - 350,000 + 22,000 x P/A(5%, 6) + 400,000 x P/F(5%, 6)

= - 350,000 + 22,000 x 5.0757 + 400,000 x 0.7462

= - 350,000 + 111,665 + 298,480

= 60,145

NPVH = - 350,000 + 22,000 x P/A(10%, 6) + 400,000 x P/F(10%, 6)

= - 350,000 + 22,000 x 4.3553 + 400,000 x 0.5645

= - 350,000 + 95,817 + 225,800

= - 28,383

Therefore,

IROR (%) = 5 + [60,145 / (60,145 + 28,383)] x (10 - 5)

= 5 + (60,145 / 88,528) x 5

= 5 + 0.6794 x 5

= 5 + 3.397

= 8.397% ~ 8.40%