mgt411 idea solution assignment no 1 spring 2011

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“Money & Banking (MGT411)”
Mr Ahmad, the director of Supreme Textile Limited, is deciding to install a new plant for fiber spinning. Mr Ahmad has a choice to install a plant that will transform the raw cotton into yarn, project costs Rs 2,000,000/- and will generate revenue of Rs 550,000 for the next five years.

Assume the company’s discount rate/cost of borrowing is 9%.
Calculate IRR for above project by using trial and error method.
The IRR is calculated by a trial and error process
1. The NPV is calculated using discount rate r.
2. If the NPV is close to zero then r is the IRR.
3. If the NPV is positive r is increased.
4. If the NPV is negative r is decreased.
First we calculate the NPV using the discount rate which is 9% given in question
NPV = CF0 + CF1/ (1+r) + CF2/ (1+r) 2 + CF3/ (1+r) 3 +CF4/ (1+r) 4 + CF5/ (1+r) 5
0= -2000000+550000/ (1.09) +550000(1.09)2+550000(1.09) 3 +550000(1.09)4 +550000(1.09)5
0= -2000000+504587+462924+424700+389633+357462
0= 139306
It is Positive so we increased our r 9% to 12% and use 12% instead of 9%
NPV = CF0 + CF1/(1+r) + CF2/(1+r)2 + CF3/(1+r)3 +CF4/(1+r)4 + CF5/(1+r)5
0= -2000000+550000/ (1.12) +550000(1.12)2+550000(1.12) 3 +550000(1.12)4 +550000(1.12)5
0= -2000000+491071+438456+391479+349534+312085
0= -17375