3. Understanding the IRR and NPV The net present value (NPV) and internal rate of return (IRR) methods of investment analysis are interrelated and are sometimes used together to make capital budgeting decisions. Consider the case of Cute Camel Woodcraft Company: Last Tuesday, Cute Camel Woodcraft Company lost a portion of its planning and financial data when both its main and its backup servers crashed. The company's CFO remembers that the internal rate of return (IRR) of Project Lambda is 13.2%, but he can't recall how much Cute Camel originally invested in the project nor the project's net present value (NPV). However, he found a note that detailed the annual net cash flows expected to be generated by Project Lambda. They are: Year Cash Flow Year 1 $2,400,000 Year 2 $4,500,000 Year 3 $4,500,000 Year 4 $4,500,000 The CFO has asked you to compute Project Lambda's initial investment using the information currently available to you. He has offered the following suggestions and observations: • A project's IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows equals the discounted value of its cash outflows-when the cash flows are discounted using the project's IRR. • The level of risk exhibited by Project Lambda is the same as that exhibited by the company's average project, which means that Project Lambda's net cash flows can be discounted using Cute Camel's 7% WACC. Given the data and hints, Project Lambda's initial investment is dollar). and its NPV is ' (rounded to the nearest whole A project's IRR will if the project's cash inflows decrease, and everything else is unaffected.
3. Understanding the IRR and NPV The net present value (NPV) and internal rate of return (IRR) methods of investment analysis are interrelated and are sometimes used together to make capital budgeting decisions. Consider the case of Cute Camel Woodcraft Company: Last Tuesday, Cute Camel Woodcraft Company lost a portion of its planning and financial data when both its main and its backup servers crashed. The company's CFO remembers that the internal rate of return (IRR) of Project Lambda is 13.2%, but he can't recall how much Cute Camel originally invested in the project nor the project's net present value (NPV). However, he found a note that detailed the annual net cash flows expected to be generated by Project Lambda. They are: Year Cash Flow Year 1 $2,400,000 Year 2 $4,500,000 Year 3 $4,500,000 Year 4 $4,500,000 The CFO has asked you to compute Project Lambda's initial investment using the information currently available to you. He has offered the following suggestions and observations: • A project's IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows equals the discounted value of its cash outflows-when the cash flows are discounted using the project's IRR. • The level of risk exhibited by Project Lambda is the same as that exhibited by the company's average project, which means that Project Lambda's net cash flows can be discounted using Cute Camel's 7% WACC. Given the data and hints, Project Lambda's initial investment is dollar). and its NPV is ' (rounded to the nearest whole A project's IRR will if the project's cash inflows decrease, and everything else is unaffected.
Chapter1: Making Economics Decisions
Section: Chapter Questions
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Transcribed Image Text:3. Understanding the IRR and NPV
The net present value (NPV) and internal rate of return (IRR) methods of investment analysis are interrelated and are sometimes used together to
make capital budgeting decisions.
Consider the case of Cute Camel Woodcraft Company:
Last Tuesday, Cute Camel Woodcraft Company lost a portion of its planning and financial data when both its main and its backup servers
crashed. The company's CFO remembers that the internal rate of return (IRR) of Project Lambda is 13.2%, but he can't recall how much
Cute Camel originally invested in the project nor the project's net present value (NPV). However, he found a note that detailed the
annual net cash flows expected to be generated by Project Lambda. They are:
Year
Cash Flow
Year 1 $2,400,000
Year 2 $4,500,000
Year 3 $4,500,000
Year 4 $4,500,000
The CFO has asked you to compute Project Lambda's initial investment using the information currently available to you. He has offered the following
suggestions and observations:
• A project's IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows
equals the discounted value of its cash outflows-when the cash flows are discounted using the project's IRR.
• The level of risk exhibited by Project Lambda is the same as that exhibited by the company's average project, which means that
Project Lambda's net cash flows can be discounted using Cute Camel's 7% WACC.
Given the data and hints, Project Lambda's initial investment is
dollar).
and its NPV is
'
(rounded to the nearest whole
A project's IRR will
if the project's cash inflows decrease, and everything else is unaffected.
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