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Investment appraisal – Discounted cash flow techniques

Question 14

IRR

Find the IRR of an investment of $20,000 if the cash flows are:

(a) $4,500 for 7 years, starting at t1

(b) $4,500 into perpetuity, starting at t1

(a)

Time Cash flow discount factor Present value

t0 (20,000) 1 (20,000)
t1–7 4,500 ? 20,000
–––––––

NPV 0

Now we can work out what the 7 year annuity factor must be:

$20,000/$4,500 = 4.44

Then look on the annuity tables to see what percentage has an annuity
factor closest to this for 7 years.

12% = 4.564, 13% = 4.423, 14% = 4.288

So the IRR is closest to 13%

(b)

IRR = $4,500/$20,000 = 0.225 or 22.5%

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