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Suppose that project's cash flows are C0 = $200, 000, C1 = −$100, 000, C2 = −$70, 000, C3 = −$50, 000
Suppose that project's cash flows are C0 = $200, 000, C1 = −$100, 000, C2 = −$70, 000, C3 = −$50, 000. Required rate of return is 10%.
(a) Based on NPV rule, should you take the project?
(b) Compute IRR of the project.
(c) Do you agree with the following statement: IRR rule prescribes to take the project if required rate of return is below IRR. However, as IRR computed in part (b) is below required rate of return, we should reject the project. If you do not agree, very briefly explain why.
Expert Solution
a) NPV of the project = $13,673.93
Since, the NPV is positive so the project should be taken.
b) IRR of the project = 5.58%
c) On the basis of IRR rule the project should not be accepted because the IRR is lower than the required rate of return (10%). Because If the IRR of project is greater than the required rate of return than the project adds value to the business and If the IRR is less than the required rate of return, it destroys value.
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