Reference no: EM133062555
NPV and IRR
You are considering a project that requires an immediate investment of $10 million (t=0), and which generates cash flows that start in three years, i.e., at the end of t=3. The cash flow at the end of t=3 is $2 million, which is expected to grow forever at 3%. (So this is a growing perpetuity.) You face some uncertainty over the discount rate, and so plan to approach this problem using both the net present value (NPV) and internal rate of return (IRR) approaches. It may be helpful to start by drawing a timeline of the cash flows.
a. Starting with a discount rate of 12%, what is the NPV of this opportunity?
b. You may face some uncertainty about the appropriate discount rate to apply to this project. Therefore, you decide to examine the internal rate of return as a point of comparison. What is the IRR, assuming the same cash flows and growth rate as above?
c. As another measure of safety for the investment, let's use our 12% discount rate but assume a less aggressive assumption around the growth rate. What if there was no growth (i.e., g=0) - what will the NPV be in this case?
d. What growth rate would you need to use along with the 12% discount rate in order to achieve a break-even outcome (i.e., NPV = 0)? Hint: set up your excel sheet so that you can easily change the growth rate in a single cell and output a new NPV for that growth rate.
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