Anderson International Limited is evaluating a project in Erewhon. The project w
ID: 2777101 • 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 4 percent. Assume Anderson uses a required return of 12 percent on this project.
What is the NPV of the project? (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places (e.g., 32.16).)
What is the IRR of the project? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Anderson International Limited is evaluating a project in Erewhon. The project will create the following cash flows:
Explanation / Answer
Solution:
The cash flows from the investment are reinvested for 1 year at the given rate of 4%, hence cash flows generated in 1st year is reinvested at 4% and recieved by the company in 2nd year and so on. So there is no cash flow received by the company in 1st year.
Required rate of return (k) = 12%
Hence, the firm generates a negative net present value of $12,270.96 from the project
Now IRR or Internal rate of return is the required rate of return at which the initial investment gets equal to present value of all future cash flows or the rate of return at which the net present value gets equal to 0
Let 'r' be the IRR,
Now this can be solved in excel using the formula for IRR = IRR(values, guess)
where values would be cash flows for all 5 years i.e. -591000, 0, 229840, 170560, 238160 and 216320. In guess, we can put any random value
Solving the formula in the excel, gives the value of IRR (r) = 11.305%
hence IRR of the project is 11.31%