i can solve the npv thats no problem. I don’t understand how they managed to get 21.4% as the irr. this is the discount that should make = -$6million + 500k/(1+r) + 4mln/(1+r)2 +4mln/(1+r)3 + 4mln/(1+r)4 ±1mln/(1+r)5 = 0. in my financial calculator i plugged in cf0 as -6million and then cf1 as 500k and so on until i reach cf5 to plug in -$1 million in the end. the irr that should solve for npv of 0 should be 21.4% and its not. 21.4% irr gives me an npv of 192k. what am i doing wrong here?
If you put those numbers into Excel and use the built-in NPV function with 18% as the discount rate, you should get an NPV of 0.43.
Unfortunately, Excel’s NPV function is stupid: it assumes that the first cash flow (−6) occurs at time 0 1, not at time 1 0. So you have to multiply the answer by 1.18 (= 1 + 18%) to get the correct answer: 0.51 (or, to 6 decimal places, 0.509579).
" it assumes that the first cash flow (−6) occurs at time 0, not at time 1" but -6 is occurring at time 0 right? the question says “Investment outlays are $6 million immediately” - i.e. time 0? Do you mind telling me what keystrokes you used on your calculator please?
My mistake: I mistyped the numbers. The built-in NPV function in Excel assumes that the first cash flow is at time 1, not a time 0. When the initial cash flow is at time 0 (i.e., always!), the function will give an incorrect amount: too small by one period’s interest.
many thanks guys. final q (I promise). I was expecting to use the irr as the discount I and see an npv of 0 which I believe is what the irr is. does this work? I didn’t see that it did. that was actually the basis for this question. so the keystrokes would be.
CF0 = -6
CF1 = -0.5
CF2 = 4
CF3 = 4
CF4 = 4
CF5 = -1
and then i as 21.4% which should give 0 npv but it doesnt.