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3. Understanding the IRR and NPV

The net present value (NPV) and internal rate of return (IRR) methods of investment analysis are interrelated and are sometimes used together to make capital budgeting decisions.

Consider the case of Blue Hamster Manufacturing Inc.:

Last Tuesday, Blue Hamster Manufacturing Inc. lost a portion of its planning and financial data when both its main and its backup servers crashed. The companys CFO remembers that the internal rate of return (IRR) of Project Omicron is 13.8%, but he cant recall how much Blue Hamster originally invested in the project nor the projects net present value (NPV). However, he found a note that detailed the annual net cash flows expected to be generated by Project Omicron. They are:

Year	Cash Flow
Year 1	$1,800,000
Year 2	$3,375,000
Year 3	$3,375,000
Year 4	$3,375,000

The CFO has asked you to compute Project Omicrons initial investment using the information currently available to you. He has offered the following suggestions and observations:

	A projects IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows equals the discounted value of its cash outflowswhen the cash flows are discounted using the projects IRR.
	The level of risk exhibited by Project Omicron is the same as that exhibited by the companys average project, which means that Project Omicrons net cash flows can be discounted using Blue Hamsters 10% WACC.

Given the data and hints, Project Omicrons initial investment is , and its NPV is (rounded to the nearest whole dollar).

A projects IRR will if the projects cash inflows increase, and everything else is unaffected.

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