CFA Practice Question

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.

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
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