CFA Practice Question
A firm has a project with the following cash flows. The cost of capital of the firm is 6% and the project has no cash flows after year 5.
0 | -4,000 (Investment)
1 | 3,500
2 | -2,400
3 | 5,000
4 | -2,700
5 | 2,000
Year | Cash Flow
0 | -4,000 (Investment)
1 | 3,500
2 | -2,400
3 | 5,000
4 | -2,700
5 | 2,000
What is the IRR for a project?
A. 14.89%
B. 9.57%
C. 14.53%
Explanation: Bring forward year 1 to 4 cash flows to year 5 @ 6% per annum. IRR will be the rate at which investment in year 0 grows to give year 5 total.
User Contributed Comments 13
| User | Comment |
|---|---|
| jsubhen | isnt the answer C, 14.53%. Havent heard this interpretation of IRR given before. |
| jpducros | Actualization of cash flow is normally not a problem but in that case my HP12C doesn't seem to be able to calculate an IRR of these cash flows (error 3). Mystery. Maybe there are several possible IRR. I solved it using the middle rate proposed (14,53) and calculated the NPV. I found it negative, so I concluded B was the only possible answer. |
| JCopeland | The fact is this project has multiple IRRs. This is a common problem when cash flows change from positive to negative several times. However, the IRR which is the discount rate at which NPV=0 is 14.53%. At 9.57% NPV is 389.36. I've never heard the current interpretation of IRR in any of the materials, graduate finance books, or on the internet. If this in fact is an accurate interpretation, can someone please tell me where to find it. |
| chantal | The material is clear on this issue. IRR cannot be calculated when cash flows are non conventionnal. To get the answer you need to : 1:Bring FORWARD to year 5 all individual CF at the cost of capital of 6% 2: add them up and enter total of 6316FV 3: Input N(5) % (6%) PV :-4000 4: CPT y= 9.56% |
| Kathkun | Thank you Chantal, for the clear and concise explanation. |
| chandsingh | How do we compute 6316? if i add the figures it is 5400 and if i discount the figures and add them up i get less than 5k? |
| chandsingh | Nevermind, i got it, compound each return till year 5. |
| safash | sorry bt how do u get 6316 |
| safash | phewwwwww got it |
| hamster | how did you got it? |
| emma51 | Can someone pls help? |
| mjwoulf | It takes a couple minutes but to get 6316: -3500 pv, 4 N, 6 i/y, 0 pmt, cpt fv = 4418.67 2400 pv, 3 N, ......fv = -2858.44 -5000 pv, 2 N,......fv = 5618 2700 pv, 1 N,.......fv = -2862 and 2000 is current year so no compounding, then follow chantel's steps 2-4. |
| davcer | we have to read carefully |