Anderson International Limited is evaluating a project in Erewhon.

The project will

create the following cash flows:

Year Cash Flow

0 -$1,310,000
1 485,000
2 550,000
3 445,000
4 400,000

All cash flows will occur in Erewhon and are expressed in dollars. In an attempt to
improve its economy, the Erewhonian government has declared that all cash flows
created by a foreign company are blocked and must be reinvested with the government
for one year. The reinvestment rate for these funds is 3 percent.

If Anderson uses a required return of 13 percent on this project, what are the NPV
and IRR of the project?
Net Present Value:

Net present value of a project is the profit measured in today's dollars. In this
method, it is implicitly assumed that the discount rate of negative cash flows is
the same as the reinvestment rate of positive cash flows.
Answer and Explanation:

We first compute the future value of positive cash flows from the project,
reinvested at the rate of 3%, i.e.,

485,000∗(1+3%)3+550,000∗(1+3%)2+445,000∗(1+3%)+440,000=2,011,817.595

Then the net present value is:

NPV = 2,011,817.595(1+13%)4−1,310,000

NPV = 470,369.55

The modified internal rate of return is:

(2,011,817.5951,310,000)1/4−1=11.32%