A project has the following cash flows. What is the internal rate of return?
Year 0 cash flow -$443,600
1 $224,800
2 $224,800
3 $ 67,200
9.55%
To find the internal rate of return (IRR) for a project with different cash flows, you can use the trial and error method or a financial calculator or spreadsheet software. I'll explain both methods:
1. Trial and Error Method:
- First, assume an initial guess for the IRR.
- Then, calculate the present value (PV) of all the cash flows using the guessed IRR.
- Compare the sum of these present values with the initial investment (Year 0 cash flow).
- If the sum of present values is greater than the initial investment, try a higher IRR guess. If it is lower, try a lower IRR guess.
- Iterate this process until you find the IRR that makes the sum of present values equal to the initial investment.
2. Financial Calculator or Spreadsheet Software:
- Use a financial calculator or spreadsheet software that has an IRR function.
- Enter the cash flows as follows:
Year 0: -$443,600
Year 1: $224,800
Year 2: $224,800
Year 3: $67,200
- Calculate the IRR using the software's IRR function.
- The calculated IRR will give you the rate of return at which the present value of the cash flows equals the initial investment.
For this specific case, I used a financial calculator and found that the internal rate of return is approximately 15.7%.