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Calculate the IRR when given terminal growth rate?
Hi,
How should the IRR be calculated with the following information?
Cash flows:
Year 0 ($500k)
Year 1 $10k
Year 2 ($50k)
Year 3 $5k
Year 4 $20k
Y5 onwards 50k (with terminal growth rate of -5%)
and discount rate of 15%.
Any help is very much appreciated.
Thanks.
0 ·
Comments
PV of Y1 to Y4 = -$14,388.89 ; using the discount rate of 15%.
PV of Y5 onwards = $1 million ; using rate of 5% (is this correct??)
What should I do next?
It seems that your PV for Y5 is incorrect, I'll have a go at detailing my steps below:
Step 1: Calculate Terminal Value at Year 5
Using the Gordon Growth model, TV = [Final year projected Cash Flow * (1 + r)] / (r - g), where r is discount rate, g is long term cash growth rate.
So TV = (50,000) * (1-5%) / (15% + 5%) --> note: the terminal growth rate g is -5% (not 5%)
= 237,500
Step 2: Input these CF values in CF worksheet
For BA II plus calculator, make sure you clear your CF worksheet before you start a new calculation (always a good practice!!), by pressing the "2ND" "CE|C" button for CLR WORK function.
So currently your cash flow (undiscounted) are as follows for the CF function:
CF0 = -$500,000
CF1 = $10,000
CF2 = -$50,000
CF3 = $5,000
CF4 = $20,000
CF5 TV = $237,500 (not sure how you got your $1m number here with PV either?)
Step 3: Calculate IRR
Based on these input, I got an answer of -14.22% IRR. Is this correct?