- This topic has 0 replies, 1 voice, and was last updated 8 years, 7 months ago by .
-
Topic
-
I’m having some trouble conceptualizing how to solve this problem. Can anyone provide a different explanation? Thanks for your help.
Allo Foundation, a tax-exempt organization, invested $200,000 in a 5-year project at the beginning of 2006. Allo estimates that the annual cash savings from this project will amount to $65,000. The $200,000 of assets will be depreciated over their 5-year life on the straight-line basis. On investments of this type, Allo’s desired rate of return is 12%. Information on present value factors is as follows:
AT 12% AT 14% AT 16%
Present value of 1 for 5 periods 0.5674 0.5194 0.4761
Present value of an annuity of
1 for 5 periods 3.6048 3.4331 3.2743
Allo’s internal rate of return on this project is:
Incorrect A.
less than 12%.
B.
less than 14%, but more than 12%.
C.
less than 16%, but more than 14%.
D.
more than 16%.
Solution:
PV of Cash Savings = PV of Investment Outlay
$65,000 x PV factor = $200,000 x 1.0
$65,000(PV factor) = $200,000
Then dividing by $65,000:
PV factor = $200,000 / $65,000
= 3.08
Referring to the present value factors in the question, the percentage rates for present value of an annuity indicates that a present value factor of 3.08 would relate to an interest rate of more than 16%.
- You must be logged in to reply to this topic.