Anderson International Limited is evaluating a project in Erewhon. The project w

Question

Anderson International Limited is evaluating a project in Erewhon. The project will create the following cash flows YearCash Flow 0 -$1,210,000 385,000 450,000 345,000 300,000 4 All cash flows will occur in Erewhon and are expressed in dollars. In an attempt to improve its economy, the Erewhonian government has declared that all cash flows created by a foreign company are "blocked" and must be reinvested with the government for one year. The reinvestment rate for these funds is 5 percent. If Anderson uses a required return of 10 percent on this project, what are the NPV and IRR of the project? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16. Enter your IRR as a percent.) NPV IRR

Explanation / Answer

1. NPV: The first step is to compute the uture value of the cash flows for the one year in which they are blocked by the government.

Thus cash flow in year 2 = 385,000*1.05 = 404,250

Cash flow in year 3 = 450,000*1.05 = 472,500

Cash flow in year 4 = 345,000*1.05 = 362,250

Cash flow in year 5 = 300,000*1.05 = 315,000

Thus NPV = -1,210,000+404,250/1.10^2 + 472,500/1.10^3+ 362,250/1.10^4 + 315,000/1.10^5

= -1,210,000+1,132,098.99

= - 77,901.01

2. IRR is the rate which makes NPV as nil. This has been computed using the trial and error approach.

Let IRR be "r"

Thus

-1,210,000+404,250/(1+r)^2 + 472,500/(1+r)^3+ 362,250/(1+r)^4 + 315,000/(1+r)^5 = 0

or r = 0.0779

Thus IRR = 7.79%

NPV -77,901.01 $ IRR 7.79 %

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