Figure 3
Glady, Inc., is considering the purchase of production equipment that costs £800,000. The equipment is expected to generate annual cash inflows of £250,000. The equipment is expected to have a useful life of five years with no salvage value. The firm's cost of capital is 14 percent.
-Refer to Figure 3. The approximate internal rate of return of Glady's project is

Question

Quizplus · Accepted Answer

The internal rate of return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. Given the cost of the equipment (£800,000), annual cash inflows (£250,000), and the useful life of the equipment (5 years), the IRR would be closest to the option that, when used as a discount rate, would make the NPV of these cash flows equal to zero. Without performing the exact calculation, which requires either trial and error or financial calculator/computer software, we know that the IRR must be higher than the firm's cost of capital (14%) because the project is presumably acceptable. Among the given options, 16% is the only rate slightly above the cost of capital, making it the most plausible approximation of the IRR for this project.

Figure 3 Glady, Inc., Is Considering the Purchase of Production Equipment That