I think this one is my favorite:
A company is evaluating two investment proposals. Project A costs $700,000 and Project B costs $500,000. Expected cash inflows for the two projects are as follows:
Cash Inflow Cash Inflow
At End of Year: At End of Year:
Year Project A Project B
—- ————— —————
1 $400,000 $250,000
2 $300,000 $250,000
3 $600,000 $250,000
Both projects are assessed as being equally risky and having an appropriate cost of capital of 10%.
For a 10% cost of capital, the following present value factors apply:
Number Present Value of Present Value of an Annuity of
of $1 Received at $1 Received at End of Each Year
Years End of Year N (PVIF) for N Years (PVIFA)
—— ——————– ——————————-
1 .9091 .9091
2 .8264 1.7355
3 .7513 2.4873
For a 3-year annuity, the following present value factors apply:
Discount Present Value of a 3-Year
Rate Annuity of $1 (PVIFA)
——– ————————-
16% 2.2459
20% 2.1065
24% 1.9813
28% 1.8684
Which of the following most closely approximates the internal rate of return of Project B?
A. 16%
B. 20%
Correct C. 24%
D. 28%
ANSWER
The internal rate of return is the discount rate that sets the net present value of a project equal to zero. At a discount rate of 24%, the net present value of Project B is:
– $500,000 + $250,000 (PVIFA (3 years, 24%)) = – $500,000 + $250,000 (1.9813) = $4,675
Of the discount rates given, this one most closely approximates the internal rate of return on Project B.
At a discount rate of 16%, the net present value of Project B is:
-$500,000 + $250,000 (PVIFA (3 years, 16%))
= -$500,000 + $250,000 (2.2459)
= $61,475
This is not as close to zero as the net present value calculated at a 24% discount rate.
At a discount rate of 20%, the net present value of Project B is:
-$500,000 + $250,000 (PVIFA (3 years, 20%))
= -$500,000 + $250,000 (2.1065) = $ 26,625
This is not as close to zero as the net present value calculated at a 24% discount rate.
At a discount rate of 28%, the net present value of Project B is:
-$500,000 + $250,000 (PVIFA (3 years, 28%))
= -$500,000 + $250,000 (1.8684)
= -$32,900
This is not as close to zero as the net present value calculated at a 24% discount rate.
CPA (2017)
REG: 75
BEC: 76
FAR: 77
AUD: 78
CMA (2019)
P1: 380
P2: 360
AUD - 1st - 60 (12/12), 61 (2/13), 61 (8/13), 78! (11/15)
REG - 55 (2/16) 69 (5/16) Retake(8/16)
BEC - 71(5/16) Retake (9/16)
FAR - (8/16)
.