Internal Rate of Return (IRR) for the Project
Step – 1, Firstly calculate NPV at a guessed discount Rate, Say 21%
Year |
Annual Cash Flow |
Present Value factor at 21% |
Present Value of Cash Flow |
1 |
40,000 |
0.82645 |
33,058 |
2 |
25,000 |
0.68301 |
17,075 |
3 |
10,000 |
0.56447 |
5,645 |
4 |
30,000 |
0.46651 |
13,995 |
5 |
35,000 |
0.38554 |
13,494 |
TOTAL |
$83,267 |
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Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment
= $83,267 - $80,000
= $3,267
Step – 2, NPV at 21% is positive, Calculate the NPV again at a higher discount rate, Say 24%
Year |
Annual Cash Flow |
Present Value factor at 24% |
Present Value of Cash Flow |
1 |
40,000 |
0.80645 |
32,258 |
2 |
25,000 |
0.65036 |
16,259 |
3 |
10,000 |
0.52449 |
5,245 |
4 |
30,000 |
0.42297 |
12,689 |
5 |
35,000 |
0.34111 |
11,939 |
TOTAL |
$78,390 |
||
Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment
= $78,390 - $80,000
= -$1,610 (Negative NPV)
Therefore IRR = R1 + NPV1(R2-R1)
NPV1-NPV2
= 0.21 + [$3,267 x (0.24 – 0.21)]
$3,267 – (-$1,610)
= 0.21 + 0.0198
= 0.2298
= 22.98%
“Therefore, The Project’s IRR = 22.98%”
“The Present Value Factor is calculated by using the formula 1/(1 + r)n, Where r is the guessed discount rate and n is the number of years”
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