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 four-year useful life, will cost $11,131.56, and will generate expected cash inflows of $4,300 per year. The second investment is expected to have a useful life of four years, will cost $12,917.30, and will generate expected cash inflows of $3,900 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 a. Calculate the internal rate of return of each investment opportunity. (Do not round intermediate calculations.) b. Based on the internal rates of return, which opportunity should V&K select?

Answer 1

IRR is the rate at which NPV = 0

First Investment

Let the rate be x

11,131.56 = 4,300*PVAF(x%, 4 years)

PVAF(x%, 4 years) = 2.5887

Using Present value annuity table, x = 20%

Hence, IRR = 20%

Second investment

PVAF = 12,917.30/3900

= 3.3121

IRR = 8%

Should select first investment as IRR is higher