I was doing Q21 in EOC of Capital Budgeting Reading 21. I didn’t understand the question.
The case says:
Investment of $500,000
Operating Income after taxes of $20,000 and depreciation of $40,000 every year for three years.
Tax rate 30%. The proposal indicates $647,500 terminal selling price will enable the company to earn a 15% IRR. Bohm (a person reviewing proposals) doubts that this terminal value is correct.
Question : What terminal selling price is required for 15% IRR on this project?
My question is how to know what is the question asking and most importantly please help on how to solve this.
The question is asking what terminal cash flow do you need to discount and add to other cash flows to get an irr of 15%. To solve, you could use trial and error method. In your calci feed in all cash flows and for the final year feed one of the options and calculate irr. The closer u get to the 15%(in this case) thats your answer.
If you get a 15% IRR with answer B, then that’s the answer. If you get an IRR greater than 15%, then the correct answer is A; if you get an IRR less than 15%, then the correct answer is C.