IRR Calculation

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  • #196564
    Anonymous
    Inactive

    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%.

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