The Potential for Multiple IRRs A proposed investment has the following projected after-taxcash flows over its 3-year life:Initial outlay (time 0) = ($1,000)End of year 1 = $2,000End of year 2 = $2,000End of year 3 = ($3,700) Required 1. In a capital budgeting context, explain the difference between a normal and a non-normal cash flowpattern. What is the importance of this distinction for estimating the internal rate of return (IRR) of aproposed investment? 2. For the proposed investment project just described, how many IRRs will there be? Why?3. Use Excel to prepare a graph of the net present value (NPV) profile of the proposed investment describedherein. On the X-axis, show discount rates from 0% to 120%, in increments of 5%. On the Y-axis, showthe estimated NPV of the project for each of the specified discount rates. (Use the built-in NPV functionin Excel to estimate the NPVs.) Based on a visual examination of the graph, what are the two estimatedIRRs for the proposed investment? 4. Use the built-in IRR function in Excel to estimate each of the two IRRs for the proposed investment. Youwill have to do this twice, once for each solution. In using the IRR function, choose a “guess” (initial estimate) percentage close to the X-intercepts depicted in the graph prepared in requirement 3. (If you omitthe initial estimate, the default value used by Excel is 10%.) Round your answers to 2 decimal places. 5. What are the primary implications of the preceding analyses, in terms of the capital budgeting process?
The Potential for Multiple IRRs A proposed investment has the following projected after-tax
cash flows over its 3-year life:
Initial outlay (time 0) = ($1,000)
End of year 1 = $2,000
End of year 2 = $2,000
End of year 3 = ($3,700)
Required
1. In a capital budgeting context, explain the difference between a normal and a non-normal cash flow
pattern. What is the importance of this distinction for estimating the
proposed investment?
2. For the proposed investment project just described, how many IRRs will there be? Why?
3. Use Excel to prepare a graph of the
herein. On the X-axis, show discount rates from 0% to 120%, in increments of 5%. On the Y-axis, show
the estimated NPV of the project for each of the specified discount rates. (Use the built-in NPV function
in Excel to estimate the NPVs.) Based on a visual examination of the graph, what are the two estimated
IRRs for the proposed investment?
4. Use the built-in IRR function in Excel to estimate each of the two IRRs for the proposed investment. You
will have to do this twice, once for each solution. In using the IRR function, choose a “guess” (initial estimate) percentage close to the X-intercepts depicted in the graph prepared in requirement 3. (If you omit
the initial estimate, the default value used by Excel is 10%.) Round your answers to 2 decimal places.
5. What are the primary implications of the preceding analyses, in terms of the capital budgeting process?
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