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IAI Actuarial Core Principles · Business Finance · Cost of capital and evaluating investment projects

A project costs Rs 100,000 now and pays Rs 60,000 at the end of year 1 and Rs 60,000 at the end of year 2. Using trial rates of 10% and 15%, NPV is Rs 4,132 at 10% and Rs -2,457 at 15% (approx). Estimating IRR by linear interpolation between the two rates, the IRR is closest to which value?

The interpolated IRR is about 13.1%. It is found as 10% plus 5% times 4,132 divided by the total gap of 6,589 between the two NPVs (positive and negative), which gives roughly 3.1 percentage points above 10%.

  1. A13.1%Correct
  2. B12.5%
  3. C11.9%
  4. D14.0%
  5. 12.0%

Explanation

Interpolation: IRR = 10% + 5% x 4,132/(4,132+2,457) = 10% + 5% x 0.6271 = 13.14%. Using 4,132/2,457 alone or averaging would give wrong values. The result is about 13.1%.

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