Chapter 4: Q11BP (page 409)

You buy a new piece of equipment for $16,230, and you receive a cash inflow of $2,500 per year for 12 years. What is the internal rate of return?

Short Answer

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Answer

The internal rate of return of the equipment is 11%.

Step by step solution

Definition of Capital Budgeting

Capital budgeting can be defined as the process by which the investors assess the different available investment options. It includes methods such as the payback method, Net present value, and IRR.

Calculation of Internal Rate of Return

Internal rate of return using the formula:

$N P V = \sum_{t = 0}^{T} \frac{C_{t}}{{(1 + I R R)}^{t}} 0 = (\begin{matrix} \frac{- $ 16, 230}{{(1 + I R R)}^{0}} + \frac{$ 2, 500}{{(1 + I R R)}^{1}} + \frac{$ 2, 500}{(1 + I R R)} + \\ \frac{$ 2, 500}{{(1 + I R R)}^{3}} + \frac{$ 2, 500}{{(1 + I R R)}^{4}} + \frac{$ 2, 500}{(1 + I R R)} + \\ \frac{$ 2, 500}{{(1 + I R R)}^{7}} + \frac{$ 2, 500}{{(1 + I R R)}^{6}} + \frac{$ 2, 500}{{(1 + I R R)}^{7}} + \frac{$ 2, 500}{{(1 + I R R)}^{8}} + \\ \frac{$ 2, 500}{{(1 + I R R)}^{9}} + \frac{$ 2, 500}{{(1 + I R R)}^{10}} + \frac{$ 2, 500}{1 + I R R^{11}} + \frac{$ 2, 500}{{(1 + I R R)}^{12}} \end{matrix}) I R R = 11 %$

Internal rate of return using appendix D: present value of an annuity

$P V_{I F A} = \frac{I n i t i a l i n v e s t m e n t}{C a s h f l o w e a c h y e a r} = \frac{$ 16, 230}{$ 2, 500} = 6.492$

For n=12, we will find 6.492 under the column of 11%. Therefore, the internal rate of return of the project is 11%.

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You buy a new piece of equipment for \(16,230, and you receive a cash inflow of \)2,500 per year for 12 years. What is the internal rate of return?

Short Answer

Step by step solution

Definition of Capital Budgeting

Calculation of Internal Rate of Return

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