ExpertHard2 marksMultiple Choice
ACCA · Question 25 · Budgeting
A company is calculating the Internal Rate of Return (IRR) for a new machine.
At a discount rate of 10%, the NPV is +$5,000.
At a discount rate of 15%, the NPV is -$2,000.
Using the interpolation formula, what is the approximate IRR?
A company is calculating the Internal Rate of Return (IRR) for a new machine.
At a discount rate of 10%, the NPV is +$5,000.
At a discount rate of 15%, the NPV is -$2,000.
Using the interpolation formula, what is the approximate IRR?
Answer options:
A.
12.50%
B.
13.57%
C.
14.12%
D.
11.43%
How to approach this question
Use the IRR interpolation formula: IRR = a + [ NPVa / (NPVa - NPVb) ] * (b - a), where 'a' is the lower rate and 'b' is the higher rate.
Full Answer
B.13.57%✓ Correct
Formula: a + [ NPVa / (NPVa - NPVb) ] * (b - a)
= 10% + [ 5,000 / (5,000 - (-2,000)) ] * (15% - 10%)
= 10% + [ 5,000 / 7,000 ] * 5%
= 10% + 3.57% = 13.57%.
Common mistakes
Subtracting the negative NPV incorrectly (e.g., 5000 - 2000 = 3000 instead of 5000 - (-2000) = 7000).
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