SCHOOL OF MANAGEMENT AND LANGUAGES 1

TUTORIAL 3 – INTERNAL RATE OF RETURN

My rich old auntie always sends me a

£100 on my birthday. To be honest, I
need some cash up front. Do you think I Tutorial 3: Student
could get £500 if I sold the right to the next 5 years’ postal orders? If not, how could I work out a
fair price for 5 years of postal orders?

1. My rich old auntie always sends me £100 on my birthday. I need some cash up
front. If I sold the right to the next 5 years payments, could I get £500? If not
what would be a fair price?

No, since present value won’t be same with future value of money. That is
meant that value of 100 will be affected by various factors such as inflation.
Fair price would be return more than 500 since time impatience, inflation and
risk factors should be taken into consideration.

2. What would it mean if I said that discounting was the reverse of the interest process?

Since interest process which is also called compounding means going forward from
PV to FV opposite process of this going back from FV to PV called discounting.

3. What is the difference between present value and net present value?

4. I invest £100 now and receive £110 in a year’s time and £121 in 2 years.
a) What is the NPV of this scheme at 10%?

b) What is the NPV at 20%?

5. Describe in one sentence how to find the internal rate of return.

Internal rate could be determined at point when NPV equals zero

6. Find the internal rate of return for the data given in Q4. Hint – try 75% and 80%.

7. Describe some of the advantages and disadvantages of payback.

Advantages:
Simple and straightforward, emphasis on early recovery of investment funds.
Disadvantages:
Cut off point is arbitrary, simple payback does not use DCF, payback may miss
important cashflow occurring after payback period is ended

TUTORIAL 3: STUDENT C37FI

SCHOOL OF MANAGEMENT AND LANGUAGES 2

8. Compare and contrast accounting rate of return with internal rate of return.

9. Why do companies sometimes use all four approaches to project appraisal?

10. The following cash flow has been estimated for an investment project:

Year Project

0 –4,000
1 2,000
2 2,000
3 100
4 100

Calculate:
a) NPV at 15%
b) Internal rate of return (Hint – try 15% and 0)
c) Payback
d) Discounted payback at 10%

TUTORIAL 3: STUDENT C37FI