Question

E11-3 Calculating Net Present Value, Internal Rate of Return [LO 11-3, 11-4 Merrill Corp. has the following information available about a potential capital investment: Initial investment Annual net income Expected life Salvage value Merrill's cost of capital $ 800,000 $ 80,000 8 years $ 90,000 7% Assume straight line depreciation method is used. Required: 1. Calculate the project's net present value. (Future Value of $1. Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Round the final answer to nearest whole dollar.) Net Present Value 2. Without making any calculations, determine whether the internal rate of return (IRR) is more or less than 7 percent. Less than 7 Percent Greater than 7 Percent

Answer 1

(1)

Depreciation per annum (by straight line method) = (initial cost - salvage value)/useful life

= ($800000 - $9000)/8 = $88750

Therefore,

Annual net cash flow = annual net income + annual depreciation

Annual net cash flow = $80000 + $88750 = $168750

Present value of annual net cash flow = present value of annual $168750 + present value of salvage value $90000

= ($168750 x 5.97130) + ($90000 x 0.58201)

= $1,007,656.875 - 52,380.9

= $955,275.975

Where, PVAF(7%, 8) = 5.97130

PVF(7%, 8) = 0.58201

Therefore,

Net present value = present value of annual net cash flow - initial investment

NPV = $955,275.975 - $800000

= $155,276

(2)

internal rate of return is greater than 7%.