Question

Your firm has been hired to develop new software for the​ university's class registration system. Under the​ contract, you will receive $ 508 comma 000 as an upfront payment. You expect the development costs to be $ 438 comma 000 per year for the next 3 years. Once the new system is in​ place, you will receive a final payment of $ 846 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

				Discounted Cash flow at 1% intervals from 1% to 40%
Year	InFlow	Outflow	NetFlow	1%	2%	3%	4%	5%	6%	7%	8%	9%	10%	11%	12%	13%	14%	15%	16%	17%	18%	19%	20%	21%	22%	23%	24%	25%	26%	27%	28%	29%	30%	31%	32%	33%	34%	35%	36%	37%	38%	39%	40%
0	508,000	-	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000	508,000
1	-	438,000	-438,000	-433,663	-429,412	-425,243	-421,154	-417,143	-413,208	-409,346	-405,556	-401,835	-398,182	-394,595	-391,071	-387,611	-384,211	-380,870	-377,586	-374,359	-371,186	-368,067	-365,000	-361,983	-359,016	-356,098	-353,226	-350,400	-347,619	-344,882	-342,188	-339,535	-336,923	-334,351	-331,818	-329,323	-326,866	-324,444	-322,059	-319,708	-317,391	-315,108	-312,857
2	-	438,000	-438,000	-429,370	-420,992	-412,857	-404,956	-397,279	-389,818	-382,566	-375,514	-368,656	-361,983	-355,491	-349,171	-343,018	-337,027	-331,191	-325,505	-319,965	-314,565	-309,300	-304,167	-299,160	-294,276	-289,510	-284,860	-280,320	-275,888	-271,561	-267,334	-263,205	-259,172	-255,230	-251,377	-247,612	-243,930	-240,329	-236,808	-233,364	-229,994	-226,696	-223,469
3	-	438,000	-438,000	-425,118	-412,737	-400,832	-389,380	-378,361	-367,753	-357,538	-347,699	-338,216	-329,076	-320,262	-311,760	-303,556	-295,638	-287,992	-280,608	-273,474	-266,580	-259,916	-253,472	-247,240	-241,210	-235,374	-229,725	-224,256	-218,959	-213,827	-208,855	-204,035	-199,363	-194,832	-190,437	-186,174	-182,037	-178,022	-174,123	-170,338	-166,662	-163,091	-159,621
4	846,000	-	846,000	812,989	781,573	751,660	723,164	696,006	670,111	645,409	621,835	599,328	577,829	557,286	537,648	518,868	500,900	483,703	467,238	451,468	436,357	421,874	407,986	394,665	381,884	369,615	357,836	346,522	335,651	325,204	315,160	305,500	296,208	287,267	278,660	270,373	262,392	254,704	247,295	240,153	233,267	226,627	220,221
	NPV		40,000.00	32,837.85	26,432.36	20,728.27	15,674.47	11,223.66	7,332.01	3,958.92	1,066.78	-1,379.34	-3,411.79	-5,060.64	-6,353.80	-7,317.19	-7,974.91	-8,349.36	-8,461.35	-8,330.27	-7,974.15	-7,409.78	-6,652.78	-5,717.70	-4,618.11	-3,366.65	-1,975.08	-454.40	1,185.17	2,934.07	4,783.40	6,724.85	8,750.67	10,853.63	13,026.98	15,264.41	17,560.05	19,908.42	22,304.37	24,743.15	27,220.28	29,731.60	32,273.22

If Cost of capital is 10%, the opportunity is not attractive as the IRR (8.4%) < Cost of capital (10%).

If final payment is $1.2m, the NPV is not zero even at 40% which is good to accept as cost of capital is 10%.