Question

The Zone Company is considering the purchase of a new machine at a cost of $1,040,000. The machine is expected to improve productivity and thereby increase cash inflows by $250,000 per year for 7 years. It will have no salvage value. The company requires a minimum rate of return of 12 percent on this type of capital investment. (Ignore income taxes for this problem.)

Required:

1. Determine the project's estimated internal rate of return (IRR), rounded to the nearest tenth of a percent. (Note: PV annuity factors for 7 years: @ 10%= 4.868; @ 11% = 4.712; @ 12% = 4.564; @ 13% = 4.423; @ 14% = 4.288; @15% = 4160; and, @ 20% = 3.605.)

2. What is the estimated accounting rate of return (ARR) (on initial investment) for the proposed project? Round your answer to 1 decimal place, e.g., 0.1224 = 12.2%.

Answer 1

A B C D E G H 1. Calculation of IRR: IRR = 11+ NPV1 (12-1) NPV1 - NPV2 Where, 11 = Lower rate of discounting rate r2 = Higher rate of discouting rate NPV1 = NPV atri NPV2 = NPV at 12 Let us assume discounting rate i.e. r1 = 15% NPV1 = PV of Annual Cash Inflows - PV of Cash Outflow = [Annual Cash Inflows*PVAF (15%, 7 years)] - PV of Cash Outflow = [ $ 250,000 * 4.160) - $ 1,040,000 Hence, (12 - 15%). IRR = 15% +_ 0 0 - NPV2 IRR = 15% 2. Calculation of Accounting Rate of Return: Accounting Rate of Return = Annual Cash Flows investment 24% Rounded to 1 Decimal Sheet1