Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
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![### Internal Rate of Return Calculation for Remodeling Project
#### Assuming a Six-Year Time Horizon
This educational exercise guides on calculating the internal rate of return (IRR) of a remodeling project using both present value factors and Excel's IRR function.
#### Annual Cash Flow Calculation:
- **Revenue:** $110,000.00
- **Less Costs:**
- Other than depreciation: $10,000.00
- Depreciation: $58,333.00
- **Income before Taxes:** $41,667.00
- **Income Tax Expense:** $8,333.00
- **Net Income:** $33,333.33
- **Add Depreciation:** $58,333.00
- **Cash Flow:** $91,667.00
#### Present Value Factor:
- **Calculation:**
\[
\text{Present Value Factor} = \frac{\$350,000}{\$91,667} = 3.82
\]
This factor indicates how the internal rate of return is calculated.
### Explanation:
The annual cash flow includes revenue and deductions for costs and depreciation, leading to a net income that is adjusted by adding back the depreciation.
The present value factor is calculated by dividing the initial investment ($350,000) by the annual cash flow ($91,667), resulting in a factor of 3.82. This factor is used to determine the IRR, which measures the profitability of the project over a six-year period.
In a practical scenario, Excel’s IRR function can provide a precise IRR by considering all periods' cash flows.](https://content.bartleby.com/qna-images/question/4fc04862-5813-4b4f-893b-efba24448b50/58b90b6d-7a10-43fc-8fc2-a9fe7784ee54/g12cs1u_processed.png)
Transcribed Image Text:### Internal Rate of Return Calculation for Remodeling Project
#### Assuming a Six-Year Time Horizon
This educational exercise guides on calculating the internal rate of return (IRR) of a remodeling project using both present value factors and Excel's IRR function.
#### Annual Cash Flow Calculation:
- **Revenue:** $110,000.00
- **Less Costs:**
- Other than depreciation: $10,000.00
- Depreciation: $58,333.00
- **Income before Taxes:** $41,667.00
- **Income Tax Expense:** $8,333.00
- **Net Income:** $33,333.33
- **Add Depreciation:** $58,333.00
- **Cash Flow:** $91,667.00
#### Present Value Factor:
- **Calculation:**
\[
\text{Present Value Factor} = \frac{\$350,000}{\$91,667} = 3.82
\]
This factor indicates how the internal rate of return is calculated.
### Explanation:
The annual cash flow includes revenue and deductions for costs and depreciation, leading to a net income that is adjusted by adding back the depreciation.
The present value factor is calculated by dividing the initial investment ($350,000) by the annual cash flow ($91,667), resulting in a factor of 3.82. This factor is used to determine the IRR, which measures the profitability of the project over a six-year period.
In a practical scenario, Excel’s IRR function can provide a precise IRR by considering all periods' cash flows.
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