A proposed investment has the following projected after-tax cash flows over its 3-year life:

Initial outlay (time 0) = ($1,000)
End of year 1 = $2,000
End of year 2 = $2,000
End of year 3 = ($3,700)

Required

1. In a capital budgeting context, explain the difference between a normal and a non-normal cash flow pattern. What is the importance of this distinction for estimating the internal rate of return (IRR) of a proposed investment?

2. For the proposed investment project just described, how many IRRs will there be? Why?

3. Use Excel to prepare a graph of the net present value (NPV) profile of the proposed investment described herein. On the X-axis, show discount rates from 0% to 120%, in increments of 5%. On the Y-axis, show the estimated NPV of the project for each of the specified discount rates. (Use the built-in NPV function in Excel to estimate the NPVs.) Based on a visual examination of the graph, what are the two estimated IRRs for the proposed investment?

4. Use the built-in IRR function in Excel to estimate each of the two IRRs for the proposed investment. You will have to do this twice, once for each solution. In using the IRR function, choose a “guess” (initial estimate) percentage close to the X-intercepts depicted in the graph prepared in requirement 3. (If you omit the initial estimate, the default value used by Excel is 10%.) Round your answers to 2 decimal places.

5. What are the primary implications of the preceding analyses, in terms of the capital budgeting process?