Concept explainers
Your brother wants to borrow $10,000 from you. He has offered to pay you back $12,000 in a year. If the cost of capital of this investment opportunity is 10%, what is its
To calculate: The net present value and internal rate of return
Introduction:
NPV and IRR help to make capital-budget decisions. It would choose an alternative or an investment to increase the value of an enterprise.
Answer to Problem 1P
The NPV is 909.09 and IRR is 20%.
Explanation of Solution
Given information: Person X’s brother wishes to borrow $10,000 from Person X and offered to pay back $12,000 per year. The cost of capital for the investment opportunity is 10%.
Formula to compute the NPV:
Compute the NPV:
Hence, the NPV is $909.09.
Formula to compute IRR:
Compute the IRR:
Hence, the IRR is 20%.
Determine the maximum deviation allowable in the cost of capital without making any changes to the decision:
The calculated internal rate of return is 20%. Hence, the cost of capital can be increased up to 10% leaving the decision unchanged.
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