Park Co. is considering an investment that requires immediate payment of $28,245 and provides expected cash inflows of $9,300 annually for four years. Assume Park Co. requires a 7% return on its investments.

Required:
a. What is the internal rate of return?
b. Based on its internal rate of return, should Park Co. make the investment?

b) Park Co should make the return because the IRR is higher than the return on investment of 7%. This implies that undertaking the investment would increase the the wealth of the shareholders

Explanation:

The IRR is the discount rate that equates the present value of cash inflows to that of cash outflows. At the IRR, the Net Present Value (NPV) of a project is equal to zero

If the IRR greater than the required rate of return , we accept the project for implementation

If the IRR is less than that the required rate , we reject the project for implementation

IRR = a% + ( NPVa/(NPVa + NPVb)× (b-a)%

NPV = PV of cash inflow - initial cost

PV of cash inflow = A× (1- (1+r)^(-n) )/r

A- cash inflow , r- rate of return, n- number of years

Step 1 :

NPVa at 7%

NPV = (9300 × (1- 1.07^(-4)/0.07 ) - 28,245 = 3,256.06

Step 2:

NPVb at 20%

NPV = (9300 × (1- 1.07^(-4)/0.07 ) - 28,245 = (4,169.77)

Step 3 :

IRR = a% + ( NPVa/(NPVa + NPVb)× (b-a)%

= 7% + (3,256.06 /(3,256.06 + 4,169.77)) × (20-7)%= 12.70

IRR = 12.70%

a) Internal rate of return (IRR) = 12.70 %

b) Park Co should make the return because the IRR (12.70%) is higher than the return on investment of 7%. This implies that undertaking the investment would increase the the wealth of the shareholders