initial investment $3,000 followed by cash flows in year 1-5: $500, $1500, $2000, $2000, $500 respectively. assuming end-of-year discounting IRR is about 30%, which is an easy level I problem. now assume the same set of cash flows in year 1-5, except the required initial investment is $2000, followed by $500 in year 1 and another $500 in year 2. would your analysis of the IRR in case 2 change depending on the following assumptions - a) the $500 investment in year 1 and 2 is capex, which is required to run the operations yet it is discretionary in the sense that if you choose to abandon the project you won’t need to pay. b) the $500 investment in year 1 and 2 is contractual payment - once you start the project, you will be legally bound to make these payments to a 3rd party regardless of whether you decide to abandon the project later. c) the $500 investment in year 1 and 2 is an earn-out payment - you might be required to make the payment if the project hits certain cash flow targets; but if it doesn’t - you may end up paying less or nothing at all. economically, it may still make sense for you to take up the project even if you dont expect to hit the projected cash flows in year 1-5 because you get the benefit of having to make lower earn-out payments.
lets make c) slightly more precise: your earn-out in year 1 is min($250+50%*CF1, $500) and your earn-out payment in year 2 is min($250+16.7%*CF2,$500) where CF1 is year 1 cash flow and CF2 is year 2 cash flow. how would your IRR analysis differ in a vs b vs c?