What is the internal rate of return of a project costing $3,000; having after-tax cash flows of $1,500 in each of the two years of its two-year life; and a salvage value of $800at the end of the second year in addition to the $1,500 cash flow

Internal rate of return =  16.3%

Explanation:

The IRR is the discount rate that equates the present value of cash inflows to that of cash outflows. At the IRR, the Net Present Value (NPV) of a project is equal to zero  

If the IRR greater than the required rate of return , we accept the project for implementation  

If the IRR is less than that the required rate , we reject the project for implementation  

IRR = a% + ( NPVa/(NPVa + NPVb)× (b-a)%

Step 1 : Calculate NPVa at 10%

NPV = PV of cash inflow - Initial cost

PV of cash inflow = 1500× ( 1- 1.1^(-2))/0.1=2,603.31

PV of salvage value = 800×  1.1^(-2) =661.16

NPV = 2,603.31 + 6,661.16  - 3000= 264.46

Step 2 :Calculate NPVb at 20%

PV of cash inflow = 1500× ( 1- 1.2^(-2))/0.2=2291.67

PV of salvage value = 800×  1.2^(-2) =555.56

NPV =2291.67 + 555.56  - 3,000  = -152.78

Step 3 : Calculate IRR

IRR = 10% + (264.46/(264.46+152.78))× (20-10)%= 16.3%

Internal rate of return =  16.3%

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