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 Green Caterpillar Garden Supplies Inc.:

Last Tuesday, Green Caterpillar Garden Supplies 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 Zeta is 14.6%, but he cant recall how much Green Caterpillar 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 Zeta. They are:

Year Cash Flow

Year 1 $2,000,000

Year 2 $3,750,000

Year 3 $3,750,000

Year 4 $3,750,000

The CFO has asked you to compute Project Zetas 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 Zeta is the same as that exhibited by the companys average project, which means that Project Zetas net cash flows can be discounted using Green Caterpillars 8% WACC.

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

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