21. An investor is considering renovating a building. The total cost of renovation is expected to be $100,000, of which 75% can be borrowed. Given the after-tax cash flows to the equity investor as showed below, what is the incremental return from renovating?
1 2 3 4 5
ATCF after renovation 9,200 10,000 12,000 14,000 316,000
ATCF-no renovation 10,000 10,200 10,440 10,680 160,900
nswer: incremental return from renovating =9.75%
Working notes for the above answer is as under
Year | ACTF After Renovation |
ACTF No Renovation | Incremental Cash Flow |
Renovation Exp | Net Flow |
0 | -100,000 | -100,000 | |||
1 | 9200 | 10,000 | -800 | -800 | |
2 | 10000 | 10200 | -200 | -200 | |
3 | 12000 | 10440 | 1,560 | 1,560 | |
4 | 14000 | 10680 | 3,320 | 3,320 | |
5 | 316000 | 160900 | 155,100 | 155,100 |
Let us find IRR by trial and error Mehod as follow
IRR= -100000 + -800(1+i)1+ -200(1+i)2+ 1560(1+i)3+ 3320(1+i)4+ 155100(1+i)5
= 9.75%