Anderson International Limited is evaluating a project in Erewhon. The project w
ID: 2612975 • Letter: A
Question
Anderson International Limited is evaluating a project in Erewhon. The project will create the following cash flows:
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 11 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.)
Anderson International Limited is evaluating a project in Erewhon. The project will create the following cash flows:
Explanation / Answer
In the above question,
Required rate of return = Finance Rate = 11%
Reinvestment Rate = 5%
Now, since all the cash flows by a foreign comany have to blocked with the government for 1 year, the compay will realise cash flows 1 year later.
For example, $415,000 generated by the project at the end of 1 year will be reinvested at 5% and the company will get 415000 * (1 + 5%) = $435,750 at the end of year 2.
Similarly, the other cash flows are realised. So, the realised cash flows look like this
Discounting the cash flows at 11%, we get the NPV as
Thus, NPV of the project =Summation of Discounted Cash Flows = -$52808.86
IRR of the Project = Discount Rate at which NPV is 0, that is,
-1240000 = 0 / (1 + IRR)1 + 353664.68 / (1 + IRR)2 + 368520.46 / (1 + IRR)3 + 259375.32 / (1 + IRR)4 + 205630.89 / (1 + IRR)5
Thus, IRR = -1.32%
(IRR can be caluclated using the syntax =irr(values) in excel, where values are the discounted cash flows).
Year Realised Cash Flow 0 -$1,240,000 1 $0 2 $435,750 3 $504,000 4 $393,750 5 $346500