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The Internal Rate of Return Method The internal rate of return method is used by Testerman Construction Co. in analyzing a capital expenditure proposal that involves an investment of $113,550 and annual net cash flows of $30,000 for each of the six years of its useful life. Present Value of an Annuity of $1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 1.833 1.736 1.690 1.626 1.528 3 2.673 2.487 2.402 2.283 2.106 4 3.465 3.170 3.037 2.855 2.589 5 4.212 3.791 3.605 3.353 2.991 6 4.917 4.355 4.111 3.785 3.326 7 5.582 4.868 4.564 4.160 3.605 8 6.210 5.335 4.968 4.487 3.837 9 6.802 5.759 5.328 4.772 4.031 10 7.360 6.145 5.650 5.019 4.192a. Determine a present value factor for an annuity of $1 which can be used in determining the internal rate of return. If required, round your answer to three decimal places.
b. Using the factor determined in part (a) and the present value of an annuity of $1 table above, determine the internal rate of return for the proposal.
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Answer:

Applicable annuity factor is 3.785.

Internal rate of return is 15%.

Explanation:

Applicable annuity factory is:  

[tex]\text{Annuity factory} = \frac{\text {Investment amount present value}}{\text {Annual cash flow}}[/tex]

[tex]= \frac{113,550}{30,000} \\\\= 3.785[/tex]

Thus, applicable annuity factory is 3.785

Applicable annuity factor is present value of investment amount divided by annual cash flow. Investment amount given is $113,550. Annual cash flow given in $30,000. Then, applicable annuity factor, $113,550 divided by $30,000, is 3.785.

Applicable annuity factory from the above is 3.785. In the present value of $1 receivable at the end of the year annuity factor tables 3.785 can be found for year six at 15%.

Thus, internal rate of return is .

Internal rate of return is 15%.

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