You are evaluating an investment that requires $1,000 upfront, and pays $100 at the end of each of the first 2 years, and an additional lump-sum of $2,000 at the end of year 2. What would happen to the IRR if the annual payments at the end of each of the first 2 years go down from $100 to $50?

a. IRR increases
b. IRR decreases
c. IRR remains constan

b. IRR decreases

Explanation:

Internal rate of return is the discount rate that equates the after tax cash flows from an investment to the amount invested.

IRR can be calculated using a financial calculator:

IRR when payment at the end of the first two years is $100

Cash flow in year 0 = -$1,000

Cash flow in year 1 = $100

Cash flow in year 2 = $100 +$2000=$2100

IRR = 50%

IRR when payment at the end of the first two years is $50

Cash flow in year 0 = -$1,000

Cash flow in year 1 = $50

Cash flow in year 2 = $50 +$2000=$2050

IRR = 45.70%

From the calculation, one can see that the IRR when cash flow at the end of the first two years was $100 is higher.

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