Question

Internal Rate of Return

Manzer Enterprises is considering two independent investments:

    A new automated materials handling system that costs $900,000 and will produce net cash inflows of $300,000 at the end of each year for the next four years.

    A computer-aided manufacturing system that costs $775,000 and will produce labor savings of $400,000 and $500,000 at the end of the first year and second year, respectively.

Manzer has a cost of capital of 8 percent.

The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems.

Required:

1. Calculate the IRR for the first investment. Enter your answers as whole percentage values (for example, 16% should be entered as "16" in the answer box).
Between  % and  %.

Determine if it is acceptable or not.
Acceptable

2. Calculate the IRR of the second investment. Use 12 percent as the first guess. Enter your answers as whole percentage values (for example, 16% should be entered as "16" in the answer box).
Between  % and  %.

Comment on its acceptability.
Acceptable

3. What if the cash flows for the first investment are $250,000 instead of $300,000? Give your answer to the nearest whole percent.
The IRR would be about  % Unacceptable investment

Answer 1

Solution 1:

Present value factor at IRR = Initial investment / Annual cash inflows = $900,000 / $300,000 = 3

Refer PV factor table at period 4, this factor falls between IRR = 12% and 13%

As IRR is greater than 8%, therefore this is acceptable investment.

Solution 2:

Let find the NPV at 12% discount rate

= ($400,000 * 0.89286 + $500,000 * 0.79719) - $775,000

= ($19,261)

Let find the NPV at 10% discount rate

= ($400,000 * 0.90909 + $500,000 * 0.82645) - $775,000 = $1,860

Therefore IRR lies between 10% and 12%

As IRR is greater than 8%, therefore this is acceptable investment.

Solution 3:

Present value factor at IRR = Initial investment / Annual cash inflows = $900,000 / $250,000 = 3.60

Refer PV factor table at period 4, this factor falls at approx IRR = 4%

As IRR is less than 8%, therefore this is unacceptable investment.