Question

Velma and Keota (V&K) is a partnership that owns a small company. It is considering two alternative investment opportunities. The first investment opportunity will have a three-year useful life, will cost $7,215.24, and will generate expected cash inflows of $2,600 per year. The second investment is expected to have a useful life of five years, will cost $16,849.46, and will generate expected cash inflows of $4,000 per year. Assume that V&K has the funds available to accept only one of the opportunities. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required

1. Calculate the internal rate of return of each investment opportunity. (Do not round intermediate calculations.)

2. Based on the internal rates of return, which opportunity should V&K select?

First investment rate of return?

second investment rate of return?

V&K should select the ?

Answer 1

Solution a:

First investment:

Present value factor at IRR = Initial investment / Annual cash inflows = $7,215.24 / 2600 = 2.775

Refer PV Factor table at 3 periods, this factor falls at IRR = 4%

Second investment:

Present value factor at IRR = Initial investment / Annual cash inflows = $16849.46 / 4000 = 4.212

Refer PV Factor table at 5 periods, this factor falls at IRR = 6%

Solution b:

V&K should select second investment as it is having highest IRR.