Internal Rate of Return and Hurdle Rate
Response to the following problem:
Nina Roberts has the opportunity to invest in a timber forest. She would have to invest $100,000. Revenues of $20,000 per year are projected for 20 years. However, these revenues will not begin coming in for five years because the timber must be seasoned before cutting and selling can begin. Ms. Roberts's hurdle rate is 10%. Ignore income taxes.
Required:
1. Calculate the internal rate of return, and determine whether or not Ms. Roberts should make the investment.
2. If Ms. Roberts has to borrow the $100,000 necessary for the investment from her bank at 12% interest, should she make the investment?
3. Interpretive Question: Why is it important for Ms. Roberts to determine her cost of capital before making this investment decision?