Question

finch company is considering investing in two new vans that are

Exercise 16-5 Determining net present value LO 16-2 Finch Company is considering investing in two new vans that are expected to generate combined cash inflows of $32,000 per year. The vans' combined purchase price is $91,000. The expected life and salvage value of each are eight years and $21100, respectively. Finch has an average cost of capital of 12 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. Calculate the net present value of the investment opportunity (Negative amount should be indicated by a minus sign. Round your intermediate calculations and final answer to 2 decimal places.) b. Indicate whether the investment opportunity is expected to earn a return that is above or below the cost of capital and whether it should be accepted Net present value Will the return be above or below the cost of capital? Should the investment opportunity be accepted?

Answer 1

a	Net Present value	76486.41
b	Will the return be above or below the cost of capital ?	Above
	Should the investment opportunity be accepted ?	YES

a)

Net present value = Present value of cash inflows - Present value of cash outflows

Calculation of Present value of cash flows =

Year	Cash flows (in $ )	present value factor at cost of capital 12% #	Present value of cash flow = cash flow * present value factor ($ )
1	32000	0.892857143	28571.43
2	32000	0.797193878	25510.20
3	32000	0.711780248	22776.97
4	32000	0.635518078	20336.58
5	32000	0.567426856	18157.66
6	32000	0.506631121	16212.20
7	32000	0.452349215	14475.17
8	32000 + 21100	0.403883228	21446.20
Total			167486.41

Present value of cash inflows = 167,486.41

Present value of cash outflows = cost of new vans = $ 91,000

Net present value = Present value of cash inflows - Present value of cash outflows

= 167,486.41 - 91,000

= $ 76486.41

# Present value factors is calculated using this formula =(1/(1+cost of capital)^{no of years})

= (1/(1+0.12)years)

b) IRR = Where NPV of Project is equal to zero

IRR =

Year	Cash flows (in $ )	present value factor at cost of capital 32% #	Present value of cash flow = cash flow * present value factor ($ )	present value factor at cost of capital 33% #	Present value of cash flow = cash flow * present value factor ($ )
0	-91000	1	-91000	1	-91000
1	32000	0.757575758	24242.42	0.751879699	24060.15
2	32000	0.573921028	18365.47	0.565323082	18090.34
3	32000	0.434788658	13913.24	0.425054949	13601.76
4	32000	0.329385347	10540.33	0.319590187	10226.89
5	32000	0.249534354	7985.10	0.240293374	7689.39
6	32000	0.189041177	6049.32	0.18067171	5781.49
7	32000	0.143213013	4582.82	0.135843391	4346.99
8	53100	0.108494707	5761.07	0.102137888	5423.52
Total			439.77		-1779.47

Using Trial and error approach, we get

IRR = 32% + ( 439.77 - 0) / [ (439.77 - (-1779.47)]

= 32.2 %

32.2% > 12 %