For the net cash flow series shown, (a) apply the two rules of sign change, (b)
ID: 2781905 • Letter: F
Question
For the net cash flow series shown, (a) apply the two rules of sign change, (b) find the external rate of return using the ROIC method at an investment rate of 15% per year, and (c) determine an using the IRR function with and without the ROIC determined in part (b). Net Cash Flow, $ 48,000 20,000 90,000 50,000 -10,000 Year 0 2 4 According to the rule of signs, there can be up to (Click to select) | rate of return values. According to the cumulative cash flow test, thevalue is 1 (Click to select) The external rate of return according to the ROIC method is L%. The rate of return using the IRR function isExplanation / Answer
According to rule of signs, number of values will be equal to number of sign changes.
Here sign changes 3 times in the cashflow series ie once from 20000 to -90000 and then from -90000 to 50000 and then from 50000 to -10000
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According to cumulative cashflow test, i doesn't have a unique value because cashflow doesn't start with a negative value and has more than one sign change
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The external rate of return can be calculated as follows
Discount the outflows at rate of investment to present values at period 0
Discount the inflows at rate of investment to future values at period 4
Then discount this Present values at i' and equate to future value
PV of outflows = -90000/(1+15%)2 -10000/(1+15%)4 = -73770.4625
FV of inflows= 48000 * (1+15%)4 + 20000 * (1+15%)3 + 50000 * (1+15%) = 171869.8
Now determine present value's future value in final year assuming a rate i'
73770.4625 * (1+i'%)4 = 171869.8
i' = 23.546%
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The rate of return using IRR function in excel is -27 %
48000 20000 -90000 50000 -10000 =IRR(A2:A6)= -27%