~

le 2: A con1pany has dcYclo pcd a unique prototy pe and spent Rs. 5 lakhs.
3111
£, p of Rs. 7 lakhs is expecte d at the year end and it is expecte d to fetch
return
:\ IJis for the next three years. Calcula te the rate of return for his prototy pe.
R' \ a1
-·. 2008) (VTU Jan.

Gircn data.
Initial cost P = Rs. 5.00.00 0
Retun1 in 1st year. R 1 = 7 lakhs
Return in 2nd. 3rd and -+th years = 3 lakhs
. - ')
l \RR - .

Solution:
Srep 1: Assume i = 5% and find P\V after drawin g CFO

R = - ooOOO R:= .300000 R,= 300000 R~= 300000

,, )I. .a j'

0 1 4

i0 o
+
P = 500000

P\Y(at i = 5° o) = P\V(ReYenues ) - P\~T(Costs)

= P\Y(R 1) + PVl ~) -1- P\Y(R) + P\V(R) - P\V(P)

= R 1(P F. 5°'o ) ) + ~(P 'F. 5%.2) + R 3(P/F, 5%,3) + R/P/F, 5%,4)

- 5:00.00 0
= 7.00 .000(0. 9524) + 3.00,00 0(0.907 0) + 3,00,00 0(0.863 8)
- 3.00,00 0(0.822 7) - 5.00,00 0
P\V(at i = sqo) = 9.4.+. 730
st 2
ep : Since P\Y is highly .-\'e. assun1e i = 2oq and find P\V 1~

P\.V(at i == 20°10) = P\Y(R ,) + P\Y(~) + P\V(R) + P\V(R ) - PW(P)

= R 1(P,F: 20~o)) + ~ (P 'F. 20%,2) + R/ P/F. 20%.3) +
R/ P1F} 10°·0,-+) - P
= 7.00,000(0 .8333) T 3.00.00 0(0.694 4) + 3,00,00 0(0 .5787 )

-L 3.00 .000(0 .-+813) .- 5.00.00 0

P\V(at i == 20°0 ) = 6.09.93 0
 _
S · · y: we have to continue the iteration. Let i = 50% and find ti1·~
tep 3: Smee PW 1s not- e, l) + R (P/F, 50% ,2) + R/P /F, 50% )
Pw r . . = 50%) == R (P/F, 5001
io, ~~ '3 -~
\at ' R (P/F 50%,4) - p
= 7 ~0,0~0(0.6667) + 3,00,000(0.4444) + 3,00,000(Q 2963)
; 3,00,000(0.1963) - 5,00,000
PW(at i == 50%) = 2,47 ,790 . . . .- o
. . . have to contmue the 1terat10n. Let 1 - 701/0 and fin
Step 4: Since P\V 1s st1ll not-Ve, "~le bl for i == 70% . We have to use comp
PW. Since table values a.re not avai a e ound intered
st

fmmulaePW(at i = 70°/o) = Ril(I :i)"] + :i)" j + R,

R,[ (I [(I~ i)" j + R,[ if]
(I jl

+ R,l(l:i)"] -p
- 7' oo ' oooll(l+01.7)1 ]
- + 3, oo, ooo[(1 ~ 7)']
+ ·

+ 3,oo,ooo( (l +~-7),] + 3,oo,ooo[ (1 + ~-7l4] - s,00,000

= 4, 11,764 + 1,03,806 + 61,062 + 35,919 - 5 ,00,000
PW(at i = 70%) = 1,12,551
Step 5: PW is still not +Ve at i = 70%. Now let i = 90% and find PW

PW(at i = 90%) = 7, 00, 000 + . 3, 00, 000 + 3, 00, 000 3, 00, 000 _ 00 OOO
(1 + 0.9)1 (1 + 0.9) 2 3
(1 + 0.9) + (1 + 0.9)4 - :, , '
PW(at i = 90%) = 18,281
Step 6: We have no other choice but to continue the iteration! Let i = 100%
and ftnd PW
7,00,000 3,00,000
PW( ati-1 001/ o)- (l-1l)1 + (l l) 2 + 3,00,000 + 3,00,000 _
. _ _
0

- + (l+l ) 3 -:,0 0,000

(l+l) '1 .
PW(at i = 100%) = - 18,750
Step 7: At last PW is a -Ve value at i = 100%!
We now have PW= 18,281 at i = 90% and PW= -18 ,750at i = 100%
.
By interpolation

PW(+Ve) ] .
i1RR =i(P w-, VE)+ [ PW( +Ve )-(PW -Ve) x 1increment in i from +Ve to - Ve\
 18, 28 l ] (l _ 0. 9)
. I11: I~ O.lJ -I [ lX, 28 1 -(- 18, 750)

0 . 9 ➔94

or
j == 94. 94 t1/o
11 ine ss wil l
.:Hi'l,"'t·e tl. 1e inte111al . 1n
rate of retu is 94.94%. Thi s me ans tha t the . . bus
l.llClt .
, ) ,li,·e profits until the rate of mterest tou che s 94. 94% bec aus e 1t 1s onl y bey ond
•)tl(l llllL ll ::- 1 \lf( C )b . di cat e Ioss. Thi s me ans tha t
"\ T w hi ch m
l l O 1. t P\\ 1Re,·enue) - • P v,.
osts eco mes -ve
ilu s n t h1 . \
S 1s extTe1nely ptofitable.
tilt' )ti~_.ll 11-"'"'
l " 0, ...
 Com pare th e three i11v c~fmu11 pn,J>'>',t1h ?i '1<, r, b1,h ·1,, H tt,,_ fir:·
.
l~x:uuplcis4:15'¼).
MAl{l~
-
Invcsf nJcnf Prop,,c; af
- Proposal l
l II HhtJ(;,(J t) t Ant HJ al ,,,t•Jr n
1,00 ,()(J(j
Proposal 2 ';,'>0,fH)O J .4f J)7 )(J <;
_Pror1()r-i al J I ,<,(J ,fJIJ, J
<,,25)001)
Life of all the three pro1>0Nah ii; I() yea r~. C,m1i>arc: lJ '> in g fJO ~.

To find f hc IJW of Prop<,s;1f J

Given,

Initial <:(>1J t, JI U~.1,<)() ,<)()(J , < IJ\ 1

Annual l{efunJ, /\ I<s. J .,()(J .,(J(Jl J 1'

Lde, J l J () y<.;n1 H , i ;v t✓t 1u, /

MJ\ RJ{ J 5c½,

.
')
 A= lOOOOO A
A

n=lO

p:::-400000

acceptable
Note: Sinc e 1,1A RR is ~iven as 15%, it means that the minimum
, f ,-emrn is 15% . Hence l can be assumed as 15% to start the trial and en~or
relit q
pniress.
Step 1: Assume i = 15 o1o
PW(at i = 15 %) = PW(Revenues) - PW(Costs)
= A(P/A,15%,10) - P
= 1,00,000(5 .0188) - 4,00,000
PW(at i = 15 %) = 1,01 ,880
Step 2: Since PW is a high +Veno increase value of i more.
Assume i = 20% and find PW
PW(a t i = 20%) = A(P /A, 20% , 10) - P
= 1,00,000(4.1925) - 4,00,000
PW(at i = 20%) = l9,250
Step 3: Since P\V is still +Ve, assume i = 25 % and find PW
PW(at i ~-= 25%) = 1,00 ,000(3 .5705) - 4,00,000
.·. PW(at i = 25%) = - 42,950
st ep 4: Now we have PW = 19 250 at i = 20% and PW = - 42,950 at i = 25 ¾
'
Thereforr we can find i at which PW = 0 by interpolation

i1R1t :::: itve + PW( +Ve ) x incr eme ntin ifro m +Ve to-V e
PW( +Ve) - PW( -Ve)

:::: 0.2+ [ 19,250 x(0.25 - 0.2)]

19 ,250 - (-42 ,950 )
1utl{:::: 0.2154
or
2
illlH ::::: LS4'Yt. ➔ is the IRR for Proposal I
To find IRR of Proposal 2
Given,
Initi al cost , P = Rs.5 ,50,000
Annual retun1 , A= Rs.1 ,40,000
n = 10 years
A
A=l40000 A

0 n=lO
1 2

P=550000

Step 1: Assume i = 15% and find PW

PW(at i = 15%) = PW(Revenues)- PW(Costs)
= A(PIA, 15% , 10) - P
= 1,40,000(5.0188) - 5,55,000
PW(at i = 15%) = 1,47,632
for PW to be equal to zero
Step 2: If we observe the equation for PW we can see that
r words we can search
the value of (P/A, i, n) should be exactly 3.9285. In othe
identify the i values
the tables book along the row n = 10 and under (PIA, i, n) and
see that (PIA , 21 %.
which fall on either side of 3.9285. When we do this, we
e find PW for these
10%) = 4.0541 while (PIA, 225, 10) = 3.9232. If we therefor
of PW closest to zero.
rates i.e., 21 % and 22%. We get the +Ve and -Ve values
a precise value fallin g
Subsequently by interpolation we can find iIRR which is
somewhere between 21 % and 22% .
.-. Assume i = 21 % and find PW
PW(at i = 21 %) = PW(revenues)-PW(Costs)
= A(P/A, 21 %, 10) - p
= 1,40,000(4.0541) - 5,50,000
PW (at i = 21 %) = 17,574
Step 3: Assume i = 22% and find PW
PW(at i = 22%) = 1,40,000(3.9232) - 5,50,000
= -752
Step 4: We have, PW = 17.5 74 at i = 21<Xi nnd PvV - 752 nl i 22'½,
Therefore by interpolation

irRR
17,5 74
=0.21+----- x (0 .2 2 - 0'11)
. L.
17,574-(-752)
lrRR = 0.2195
or
iIRR = 21.95% ➔ This is the lnte111al rate of return for proposa l 2.
TQ find IRR of Proposal 3
Given,/P = 6,25 ,000
A= 1,60,000
n = 10 years

A=l60000 A A

0
'
_J n= IO

P=625000

Step 1: Assume i = 15% and find PW

PW(at i = 15%) = PW(Revenues) - PW(Costs)
= A(PIA, 15%, l 0) - P
= 1,60,000(5 .0188) - 6,25,000
= 1,78,008
Step 2: Assume i = 23% and find PW
PW(at i = 23 %) = A(P/A, 23%, l 0) - p
= 1,60,000(3.7993) - 6,25 ,000
=-17 ,112
Step 3: By interpolation

ifRR=0.15+ 1,78 ,008 ~

1,78 ,008 +17 , l l2 x (0. 23 -0 . I))
iUUl = 0.2229
or
irRR = 22.29% ➔ This is the IRR of proposal 3
Solution: Following-is the ranking of IRR of the 3 proposals

· Proposal IRR(¾)
1 21.54
2 21.95
3 22.29

Comparing the IRR of the 3 proposals it is advised to go for proposal 3. This i

because under normal circumstances as is in this problem, the best proposal is the one wi~
the highest -IRR. It is also to be noted here that the IRR values of all proposals are more
than MARR which is given in the problem as l5%.