How is IRR calculated with equal net cash inflows?
By subtracting the anticipated future cash flows from the initial beginning value, dividing the result by the actual value, and multiplying the result by 100, one can determine the internal rate of return.
Imagine that an investor requires $10,00,000 to fund a project that will provide $305,450 in cash flow annually for five years. The IRR is the rate at which those future cash flows can be valued at $10,00,000.
Initial investment = PV of net cash inflows
Initial investment = Amount of each cash inflow * Annuity PV factor (i = ?, n =5)
Annuity PV factor = Initial investment / Amount of each cash inflow
= 10,00,000 / 305450
Comparing present value chart here i = 16% that is IRR.
John Johnson is the majority stockholder in Johnson’s Landscape Company, owning 52% of the company’s stock. John asked his accountant to prepare a capital investment analysis to purchase new mowers. John used the analysis to persuade a loan officer at the local bank to loan the company $100,000. Once the loan was secured, John used the cash to remodel his home, updating the kitchen and bathrooms, installing new flooring, and adding a pool.
1. Are John’s actions fraudulent? Why or why not? Does John’s percentage of ownership affect your answer?
2. What steps could the bank take to prevent this type of activity?
Use the Present Value of $1 table (Appendix A, Table A-1) to determine the present value of $1 received one year from now. Assume a 8% interest rate. Use the same table to find the present value of $1 received two years from now. Continue this process for a total of five years. Round to three decimal places.
1. What is the total present value of the cash flows received over the five-year period?
2. Could you characterize this stream of cash flows as an annuity? Why or why not?
3. Use the Present Value of Ordinary Annuity of $1 table (Appendix A, Table A-2) to determine the present value of the same stream of cash flows. Compare your results to your answer to Requirement 1.
4. Explain your findings.
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