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 Rundle 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 five 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 $112,000 and for Project B are $34,000. The annual expected cash inflows are $28,794 for Project A and $10,384 for Project B. Both investments are expected to provide cash flow benefits for the next five years. Rundle Enterprises cost of capital is 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. Compute the net present value of each project. Which project should be adopted based on the net present value approach? b. 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. Required A Required B Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach? Internal Rate of Return Project A Project B Which project should be adopted?

Answer 1

Computation of Net Present Value of each project :- Present Project A Project B Year PVF @8% Value - PVF @8% Cashflows Cashflows Project A (1,12,000) 1.0000 (1,12,000) (34,000) 1.0000 28,794 0.9259 26,661 10,384 0.9259 28,794 0.8573 24,686 10,384 0.8573 28,794 0.7938 22,858 10,384 0.7938 28,794 0.7350 21,164 10,384 0.7350 28,794 0.6806 19,597 10,384 0.6806 Present Value 2,966 Present Value Present Value - Project B (34,000) 9,615 8,903 8,243 7,633 7,067 7,460 Net Present value of Project A is $ 2,966 and Project B is $ 7,460 Using Net Present value, Project with higher net present value will be selected. So project B is selected. Present Project B Year Cashflows Internal rate of return (IRR) is the rate at which the Net Present value of Project cashflows is ZERO. Using trial and error method IRR can be found as below :- Computation of Internal Rate of Return of each project :- Present Project A PVF @9% Value - PVF @16% Value - Cashflows Project A Car Project B 0 (1,12,000) 1.0000 (1,12,000) (34,000) 1.0000 (34,000) 28,794 0.9174 26,417 10,384 0.8621 8,952 28,794 0.8417 24,235 10,384 0.7432 7,717 28,794 0.7722 22,234 10,384 0.6407 6,653 28,794 0.7084 20,398 10,384 0.5523 5,735 28,794 0.6499 18,714 10,384 0.4761 4,944 Present Value (1) Present Value 0 Internal rate of return for Project A is 9% and Project B is 16% Since internal rate of return of Project B is more than Project A, Project B is selected