IRR Calc - Corp Fin

CFA Level II
#1

Hey guys there is a CFA EOC that asks the following (question modified as its quite long)

What is the terminal selling price require for 15% IRR if item is sold after 3 years:

A: 588,028

B: 593,771

C: 625,839

The outlay is 500,000

After tax CF is 60,000

Book Value at sale is 380,000

I am trying to do the following:

CF0= -500,000

CF1 = 60,000

CF2 = 60,000

CF3 = 133,751 (working below)

Salvage above we are trying to work out so the correct answer is C. If we plug in C to the formula T(Salt-BVt) = 0.30(625,839-380,000) = 73,751. This is then added to CF3 = 60,000 + 73.751 = 133,751

With all this in mind, can we not put these cash flows in and then just go to the IRR function and press CPT and surely this would return 15% which would suggest C is the official answer. Doing this returns -24.77% IRR.

Can someone please advise?

Question 21 P 75 Corp Fin CFA EOC

#2

EDIT ABOVE: CF 2 = 60,000 NOT 60,000 + Salvage. Salvage is for CF3. This was just a typo. The answer is still incorrect,

#3

Upon re reading that its still not clear sorry.

To confirm my calculator workings that are not giving the right answer are:

CF0 = -500,000

CF1 = 60,000

CF2 = 60,000

CF3 = 133,751

There are only 3 cash flows as the item is sold after year 3

#4

Your End Cash flow is wrong.

Say you worked with

500 = 60/1.15 + 60/1.15^2 + X/1.15^3

X = 612.0875

Now 612.0875 = Salvage Value + 60 - 0.3 (Salvage - 380)

Solve for Salvage from above

Salvage=625.839

The mistake you were making is that you were failing to realize that you are also receiving the Salvage Value as a Cashflow at the end, and paying taxes on the excess of Salvage Value over Book Value (380 K) Plus receiving a 60 K Regular project cash flow.

#5

Hi CPK, thanks for the info- i’m sorry I am still a little unclear.

Can you please show me where 625.839 came from and how you derived the formula to show Salvage = 635.839.

Can this be done on CF function?

#6

It is all algebra under the hoods.

Did you get this equation?

Step 1: 500 = 60/1.15 + 60/1.15^2 + X/1.15^3

Step 2: From that can you solve and get to X=612.0875?

Step 3:

612.0875 = SV + 60 - 0.3 (SV-380)

Do you get this?

Then

612.0875 -60 = SV - 0.3 SV + 114

0.7 SV = 612.0875 - 60 - 114

0.7 SV = 438.0875

SV = 438.0875 / 0.7 = 625.839

AND No I do not know of a way to do it with the Cashflow function directly with the calculator.

#7

got it CPK, Thanks a million