Solutions to CHAPTER 5

# Solutions to CHAPTER 5 - CHAPTER 5 NET PRESENT VALUE AND...

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CHAPTER 5 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA Solutions to Questions and Problems 5. The IRR is the interest rate that makes the NPV of the project equal to zero. So, the equation that defines the IRR for this project is: 0 = C 0 + C 1 / (1 + IRR) + C 2 / (1 + IRR) 2 + C 3 / (1 + IRR) 3 0 = –\$20,000 + \$8,500/(1 + IRR) + \$10,200/(1 + IRR) 2 + \$6,200/(1 + IRR) 3 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 12.41% Since the IRR is greater than the required return we would accept the project. 10. a. The IRR is the interest rate that makes the NPV of the project equal to zero. So, the equation that defines the IRR for this project is: 0 = C 0 + C 1 / (1 + IRR) + C 2 / (1 + IRR) 2 + C 3 / (1 + IRR) 3 + C 4 / (1 + IRR) 4 0 = \$7,000 – \$3,700 / (1 + IRR) – \$2,400 / (1 + IRR) 2 – \$1,500 / (1 + IRR) 3 – \$1,200 / (1 +IRR) 4 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 12.40% b. This problem differs from previous ones because the initial cash flow is positive and all future cash flows are negative. In other words, this is a financing-type project, while previous projects were investing-type projects. For financing situations, accept the project when the IRR is less

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