Question

Dwight Donovan, the president of Baird 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 $114,000 and for Project B are $35,000. The annual expected cash inflows are $35,188 for Project A and $11,041 for Project B. Both investments are expected to provide cash flow benefits for the next four years. Baird Enterprises’ cost of capital is 8 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?

Answer 1

Solution a:

Computation of NPV
			Project A		Project B
Particulars	Period	PV Factor (8%)	Amount	Present Value	Amount	Present Value
Cash outflows:
Initial investment	0	1	$114,000	$114,000	$35,000	$35,000
Present Value of Cash outflows (A)				$114,000		$35,000
Cash Inflows
Annual cash inflows	1-4	3.31213	$35,188	$116,547	$11,041	$36,569
Present Value of Cash Inflows (B)				$116,547		$36,569
Net Present Value (NPV) (B-A)				$2,547		$1,569

Project A should be accepted based on NPV approach.

Solution b:

Computation of IRR
Period	First investment		Second investment
	Cash Flows	IRR	Cash Flows	IRR
0	-$114,000.00	9.00%	-$35,000.00	10.00%
1	$35,188.00		$11,041.00
2	$35,188.00		$11,041.00
3	$35,188.00		$11,041.00
4	$35,188.00		$11,041.00

Project B should be adopted based on IRR approach.

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