IRR concept

CFA Level II
#1

Hi guys I ahve a question on irr here.

[question removed by moderator]

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?

#2

cf1 = −500,000

#3

yes sorry thats a typo cfo is -500k. I still cannto get the correct answer. I proved this out on excel as well and I get 192k.

#4

Ugh Sorry cf1 is -500k lol.

#5

yes tried plugging in the above values just now and still 192k. I’m doing something stupid here. I just don’t know what it is.

#6

When I put cf1 = −500,000 I get the correct answers in Excel.

I just verified that I got the correct IRR on my HP 12C.

#7

Very odd. So just to confirm. These are the keystrokes

CF0 = -6

CF1 = -0.5

CF2 = 4

CF3 = 4

CF4 = 4

CF5 = -1

when you solve for npv you get 0? Is there any way i can share my excel calculations with you?

#8

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).

Sigh.

#9

" 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?

#10

I used CF0 = -6, C01 = -0.5, F01 = 1, C02 = 4, F02 = 3, C03 = -1 ,2nd Quit, IRR CPT 21.40136

For NPV, I=18 CPT NPV 0.50958

#11

The sample excel file for the NPV and IRR calculation can be found here:

https://drive.google.com/a/riskmaestro.com/file/d/1YE7ne06sw8J2ZzI8uHiglJnmCPSIUoc1/view?usp=drivesdk

Calculator keystroke on Texas BA II is as follows:

[CF]

[2ND] [CE|C]

CF0 = -6

C01 = -0.5

F01 = 1

C02 = 4

F02 = 3

C03 = -1

F03 = 1

[NPV]

I = 18 [Arrow Down]

NPV = [CPT] 0.509579 ($509,579)

[IRR] [CPT] 21.40

#12

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.

#13

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.

#14

Yes, it should.

I just tried it and got an NPV of 0.0002: close enough.

I’m not sure what you’re doing wrong.

#15

That’s cause you rounded it off to one decimal place. When you compute the IRR you should store the full numerical answer and use it for your NPV computation.

#16

Fino you are on the money with that comment. I plugged in the numbers as millions and got around 0.16 as the npv which is close enough for me. Thanks very much and thanks to you too S2000.

#17

My pleasure.