Multiple IRR problem

aroranidhi2004
Finance Junkie
Posts: 41
Joined: Thu Oct 16, 2014 4:51 pm

Multiple IRR problem

Postby aroranidhi2004 » Tue Nov 11, 2014 9:45 pm

Which of the following statements about the internal rate of return (IRR) for a project with the following cash flow pattern is CORRECT?

Year 0: -$ 2,000
Year 1: $10,000
Year 2: -$ 10,000

A) It has two IRRs of approximately 38% and 260%.

B) No IRRs can be calculated.

C) It has a single IRR of approximately 38%.

Please help me with this question. How we can identity/calculate multiple IRR in this case.

Regards,
Nidhi

edupristine
Finance Junkie
Posts: 722
Joined: Wed Apr 09, 2014 6:28 am

Multiple IRR problem

Postby edupristine » Wed Nov 12, 2014 5:54 am

In order to calculate IRR, you have to solve the following equation for r
-2000 + 10000/(1+r) - 10000/(1+r)^2 = 0

you will get two values (solve the quadratic equation).

Or

As a shortcut, instead of solving the above quadratic equation, you can check answers by the following calculation:

10,000 ÷ 1.38 - 10,000 ÷ 1.382 = 1995.38

And:

10,000 ÷ 3.6 - 10,000 ÷ 3.62 = 2006.17

Both discount rates give NPVs of approximately zero and thus, are IRRs.

Here the discount factors used are 1.38 (1+0.38) & 3.6 (1+2.6)

Hence the correct option is ( A )

aroranidhi2004
Finance Junkie
Posts: 41
Joined: Thu Oct 16, 2014 4:51 pm

Postby aroranidhi2004 » Wed Nov 12, 2014 6:22 am

Thanks..


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