FM11 32 - equation is solved for NPV while in the IRR...

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d. 1. Define the term Internal Rate Of Return (IRR) . What is each franchise's IRR? Answer: The internal rate of return (IRR) is that discount rate which forces the NPV of a project to equal zero: 0 1 2 3 | | | | IRR CF 0 CF 1 CF 2 CF 3 PVCF 1 PVCF 2 PVCF 3 0 = SUM OF PVs = NPV. Mini Case: 11 - 32 Expressed as an equation, we have: IRR: = + n 0 t t t ) IRR 1 ( CF = $0 = NPV. Note that the IRR equation is the same as the NPV equation, except that to find the IRR the equation is solved for the particular discount rate, IRR, which forces the project's NPV to equal zero (the IRR) rather than using the cost of capital (r) in the denominator and finding NPV. Thus, the two approaches differ in only one respect: in the NPV method, a discount rate is specified (the project's cost of capital) and the
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Unformatted text preview: equation is solved for NPV, while in the IRR method, the NPV is specified to equal zero and the discount rate (IRR) which forces this equality is found. Franchise L's IRR is 18.1 percent: 0 1 2 3 | | | | -100.00 10 60 80 8.47 43.02 48.57 18.1% $ 0.06 ≈ $0 if IRR L = 18.1% is used as the discount rate. therefore, IRR L ≈ 18.1%. A financial calculator is extremely helpful when calculating IRRs. The cash flows are entered sequentially, and then the IRR button is pressed. For franchise S, IRR S ≈ 23.6%. Note that with many calculators, you can enter the cash flows into the cash flow register, also enter r = i, and then calculate both NPV and IRR by pressing the appropriate buttons....
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