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Chap016

# Ts life the internal rate of return is computed by

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Unformatted text preview: s life. • The internal rate of return is computed by • The internal rate of return is computed by ffinding the discount rate that will cause the inding the discount rate that will cause the net present value of a project to be zero. net present value of a project to be zero. 16-8 Internal-Rate-of-Return Method Internal-Rate-of-Return • Black Co. can purchase a new machine at a • Black Co. can purchase a new machine at a cost of \$104,320 that will save \$20,000 per cost of \$104,320 that will save \$20,000 per year in cash operating costs. year in cash operating costs. • The machine has a 10-year life. • The machine has a 10-year life. 16-9 Internal-Rate-of-Return Method Internal-Rate-of-Return Future cash flows are the same every year in this example, so we can calculate the internal rate of return as follows: Investment required Net annual cash flows Net \$104, 320 \$20,000 \$20,000 = Present value factor Present = 5.216 5.216 16-10 Internal-Rate-of-Return Method Internal-Rate-of-Return The present value factor (5.216) is located on The present value factor (5.216) is located on tthe Table IV in the Appendix. Scan the 10he Table IV in the Appendix. Scan the 10period row and locate the value 5.216. Look period row and locate the value 5.216. Look att the top of the column and you find a rate of a the top of the column and you find a rate of 14% which is the internal rate of return. 14% which is the internal rate of return. \$104, 320 \$20,000 \$20,000 = 5.216 16-11 Internal-Rate-of-Return Method Internal-Rate-of-Return Here’s the proof . . . 16-12 Comparing the NPV and IRR Methods Methods Net Present Value Net Present Value y The cost of capital is y The cost of capital is used as the actual used as the actual discount rate. discount rate. y Any project with a y Any project with a negative net present negative net present value is rejected. value is rejected. Internal Rate of Return y The cost of capital is compared to the internal rate of return on a project. y To be acceptable, a project’s rate of return must be greater than the cost of ca...
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