Calculate the Internal Rate of Return (IRR) for an Investment | CFA Level 1 Exam Prep

A

$1,000 = $60/Irr; IRR = 0.06 = 6%.

To calculate the internal rate of return (IRR), we need to find the discount rate at which the present value of the investment's cash flows equals its initial investment. In this case, the investment generates a constant annual return of $60 forever.

Let's break down the problem step by step:

Step 1: Identify the cash flows: We have an initial investment of $1,000, and it generates a cash flow of $60 per year indefinitely.

Step 2: Set up the equation: The IRR is the discount rate at which the present value of the cash flows equals the initial investment. Mathematically, we can express this as: $1,000 = $60 / r

Where r is the discount rate or the IRR.

Step 3: Solve the equation: To find the IRR, we need to solve the equation for r. Rearranging the equation, we get: r = $60 / $1,000

Simplifying this, we find that r = 0.06, which is equivalent to 6%.

Step 4: Interpret the result: The IRR of the investment is 6.00%, which means that if you invest $1,000 and receive a constant annual return of $60, the investment would generate a 6.00% return on your initial investment.

Therefore, the correct answer is option A. 6.00%.