CFA Practice Question

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CFA Practice Question

Martin Computers is analyzing a project with the following cash flows:

CF0 = -256,000; CF1 = 56,000; CF2 = 85,000; CF3 = 125,000; CF4 = 67,000.

Martin's cost of funds is 14% for such a project. What is the IRR of the project? Should Martin accept the project?

A. 10.8%; Accept
B. 16.5%: Accept
C. 10.8%; Reject
Correct Answer: C

The IRR of a project is computed by setting its NPV to zero. Using a financial calculator, enter the cash flows as before and solve for IRR. IRR = 10.82% < 14% (the cost of funds for Martin). The project should be rejected.

User Contributed Comments 8

User Comment
HBomb hi. anyone know how to do this without using a fin calc. i dont have one as yet. cheers.
myanmar HBomb: to solve this problem without calc. is rather hard, you have to try with linear interpolation --> set the cash flow stream equal zero and try some IRR's until you get zero in this equation.
jessied Or you can try to solve it by excel by setting cash flow stream and then inserting the function IRR in another cell.
0is4eva You know from the previous question that the present value was negative, that the project should be rejected.
You also know that the cost of funds is 14%, and since the project should be rejected, the IRR must be lower than 14%.
Two "reject"-choices, one with 16.5% and the other with 10.8% but only 10.8% is lower than 14%. Thus C, all other choices have been eliminated.

You don't need a calculator to find the correct answer to this question.
0is4eva To HBomb and other in similar situation: Download simulator of HP12C on your computer, and use that for your calculations. There are links to simulators in the Forum.
fedha using BA II

johntan1979 Wrong logic by 0is4eva. It is NOT all the time the NPV rule agrees with the IRR rule. Don't simply assume. Work it out. Practice questions are not meant to make smart-***es out of you.
IatLs HBomb, you could also use Excel.
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