Question

Problem 16-19 Using net present value and internal rate of return to evaluate investment opportunities LO 16-2, 16-3

Dwight Donovan, the president of Gibson Enterprises, is considering two investment opportunities. Because of limited resources, he will be able to invest in only one of them. Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of four years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment. Initial cash expenditures for Project A are $117,000 and for Project B are $43,000. The annual expected cash inflows are $36,114 for Project A and $13,565 for Project B. Both investments are expected to provide cash flow benefits for the next four years. Gibson Enterprises’ cost of capital is 6 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required

1. Compute the net present value of each project. Which project should be adopted based on the net present value approach?

2. Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach?
   Complete this question by entering your answers in the tabs below. points Required A Required B eBook Print Compute the net present value of each project. Which project should be adopted based on the net present value approach? (Round your intermediate calculations and final answers to 2 decimal places.) References Net Present Value Project A Project B Which project should be adopted? Required A Required B
   

Answer 1

Solution a:

Computation of NPV
			Project A		Project B
Particulars	Period	PV Factor (6%)	Amount	Present Value	Amount	Present Value
Cash outflows:
Initial investment	0	1	$117,000	$117,000	$43,000	$43,000
Present Value of Cash outflows (A)				$117,000		$43,000
Cash Inflows
Annual cash inflows	1-4	3.46511	$36,114	$125,139	$13,565	$47,004
Present Value of Cash Inflows (B)				$125,139		$47,004
Net Present Value (NPV) (B-A)				$8,139		$4,004

Solution b:

Computation of IRR
Period	First investment		Second investment
	Cash Flows	IRR	Cash Flows	IRR
0	-$117,000.00	9.00%	-$43,000.00	10.00%
1	$36,114.00		$13,565.00
2	$36,114.00		$13,565.00
3	$36,114.00		$13,565.00
4	$36,114.00		$13,565.00

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