Please explain and show the work to determine IRR calculation. Why is it 16.67%
ID: 2760507 • Letter: P
Question
Please explain and show the work to determine IRR calculation. Why is it 16.67% and not 29% or 33%? I have gotten two different answers.
PLEASE WORK OUT PROBLEM AND SHOW WORK The company can purchase new planning software for $3,600. The software (asset) has a two-year life, will produce a savings of $600 in the first year and $4,200 in the second year. The discount rate is 15%. Calculate the project's payback and discounted payback period assuming steady cash flows. Also calculate the project's NPV and IRR. Should the project be funded? In light of the previous information provided, is the 15% discount rate justified. Explain your answer. Concept Check: Payback analysis is the first step in project evaluation. The calculation enables you to understand if you can simply cover the investment within a certain time period. When doing Discounted Payback analysis or NPV analysis, a discounting rate is used to reduce future cash flows to a present value. The discount rate can be determined in many ways; existing cost of capital, projected cost of capital, desired return rate, etc as long as you justify what you wish to use for discounting cash flows and are consistent in your application evaluation will be easier. Helpful Hint: IRR is discovered when you calculate an NPV where the result is zero (or as close to zero as you can get); this is an iterative process of adjusting the discount rate until you arrive at zero for an NPV. The best thing to do is first calculate NPV and see how far away from zero you are – you can then increase or decrease the discount rate until your NPV = zero.
Explanation / Answer
Payback Period:
Payback period is the total time required to recover all the invested amount in a project by the cash inflows generated from the project.
Payback Period = 1.014285 Years
Discount Payback Period:
It again calculates the time required to recover the invested amount but the cash inflows are discounted.
Discounted Cash Flow in year 1 = $600/(1.15) = $521.74
Discounted Cash Flow in year 2 = $4,200/(1.15)2 = $3,175.80
Amount to be recovered in year 2 = $3,600 - $521.74 = $3,078.26
Discounted Payback Period = 1 Year + ($3,078.26/$3,175.80) = 1.9692 Years
NPV:
=> -$3,600 + [($600)/(1.15)] + [($4,200)/(1.15)2] = $97.54
IRR:
IRR is the rate of return at which the NPV is 0. So, to calculate this we set NPV to 0:
0 = -$3,600 + [($600)/(IRR)] + [($4,200)/(IRR)2
IRR = 16.67%