IAI Actuarial Core Principles · Actuarial Mathematics for Modelling · Project appraisal
An investment requires Rs 10,000 now and pays Rs 5,500 at the end of year 1 and Rs 6,050 at the end of year 2. What is the internal rate of return (effective annual)?
The IRR is 10.00%. At 10% effective, the receipts discount to 5,000 plus 5,000, which equals the initial outlay of 10,000, so the equation of value holds and NPV is zero. Simple averaging of the total profit would give a wrong figure.
- A5.50%
- B10.00%Correct
- C7.75%
- D15.50%
- 12.00%
Explanation
At i = 10%, 5,500/1.1 = 5,000 and 6,050/1.21 = 5,000, so the PV of receipts is 10,000 and the NPV is zero. The IRR is therefore 10%. Dividing the total gain of 1,550 by 2 years and 10,000 gives 7.75%, which ignores compounding and the timing of the receipts.
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