Question

An investment of $210 produces a perpetual stream of cash inflows. Next year, the cash inflow will be $10.50, and the cash inflow will grow at 5% per year. What is the internal rate of return on this investment?

Answer 1

Answer:

The answer is the internal rate of return on this investment is 10%.

Explanation:

The internal rate of return is the discount rate bringing the present value of the perpetual stream of cash inflows equal to its initial investment which is $210.

We apply the formula for calculating the present value of growing perpetuity to find out the internal rate of return, which is denoted as X in the below equation:

10.5/ ( X - 5%) = 210 <=> X - 5% = 10.5 / 210 = 5% <=> X = 5% + 5% = 10%.

So, the internal rate of return on this investment is 10%.