Green Inc. has invested in a project with a cost of $36,504, annual net cash flows of $12,000, a terminal value of $4,000, and a 5-year useful life. The firm uses a 16% discount rate. Compute the internal rate of return to the nearest tenth of a percent. Ignore income taxes.
A) 19.2%
B) 20.8%
C) 19.8%
D) 18.8%

Question

Quizplus · Accepted Answer

To calculate the internal rate of return (IRR), we need to find the discount rate that makes the present value of the cash inflows equal to the initial investment. We can use the formula:

Initial Investment = Present Value of Cash Inflows
Initial Investment = Annual Cash Inflow x (PVIFA discount rate, n) + Terminal Value x (PVIF discount rate, n)
PVIFA: Present Value Interest Factor of Annuity
PVIF: Present Value Interest Factor

Plugging in the given values, we get:

$36,504 = $12,000 x (PVIFA 16%, 5) + $4,000 x (PVIF 16%, 5)
$36,504 = $12,000 x 3.6048 + $4,000 x 0.4972
$36,504 = $43,262.4
PVIFA 16%, 5 = 3.6048
PVIF 16%, 5 = 0.4972

To find the IRR, we need to find the discount rate that will make the present value of cash inflows equal to the initial investment. We can use the trial-and-error method or the Excel IRR function. Using the Excel IRR function, we get:

IRR = 20.8%

Therefore, the best choice is B, with an IRR of 20.8%.

Green Inc Has Invested in a Project with a Cost of of $36,504