Question

Henrie's Drapery Service is investigating the purchase of a new machine for cleaning and blocking drapes. The machine would cost $151,640, including freight and installation. Henrie's estimated the new machine would increase the company's cash inflows, net of expenses, by $40,000 per year. The machine would have a five-year useful life and no salvage value. 10 points Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using table. Required: 1.What is the machine's internal rate of return? (Round your answer to whole decimal place i.e. 0.123 should be considered as 12%.) 2. Using a discount rate of 10%, what is the machine's net present value? Interpret your results. 3. Suppose the new machine would increase the company's annual cash inflows, net of expenses, by only $35,030 per year. Under these conditions, what is the internal rate of return? (Round your answer to whole decimal place i.e. 0.123 should be considered as 12%.) eBook Ask Print Internal rate of 1. return % References 2. Net present value Internal rate of 3. return %

Answer 1

1)	To Calculate IRR we need to calculate NPV at two rates, High rate and low rate
	let us calculate NPV at 10% & 15% discount rate
	Year	Particular	Cash Flow	Discounting Factor 10%	DCF	Discounting Factor 15%	DCF
	a	b
	0	Initial Costs	$                -1,51,640	1.000	$      -1,51,640.00	1.000	$        -1,51,640.0
	1	Annual Cash Inflows	$                     40,000	0.909	$           36,363.64	0.870	$              34,782.6
	2	Annual Cash Inflows	$                     40,000	0.826	$           33,057.85	0.756	$              30,245.7
	3	Annual Cash Inflows	$                     40,000	0.751	$           30,052.59	0.658	$              26,300.6
	4	Annual Cash Inflows	$                     40,000	0.683	$           27,320.54	0.572	$              22,870.1
	5	Annual Cash Inflows	$                     40,000	0.621	$           24,836.85	0.497	$              19,887.1
		Present Value Of Cash Flow			$                    -8.53		$          -17,553.80
		Therefore IRR by interpolation method
			= 10% + (171.47/(171.47+17373.8)*5
			=10.04%
			=10%
2)	NPV = $0
	(calculated in above solution)
3)	Revised IRR
	It seems that NPV at 10% would be negative hence we need to calculate NPV with below 10% rate say 5%
	Year	Particular	Cash Flow	Discounting Factor 10%	DCF	Discounting Factor 5%	DCF
	a	b
	0	Initial Costs	$                -1,51,640	1.000	$      -1,51,640.00	1.000	$        -1,51,640.0
	1	Annual Cash Inflows	$                     35,030	0.909	$           31,845.45	0.952	$              33,361.9
	2	Annual Cash Inflows	$                     35,030	0.826	$           28,950.41	0.907	$              31,773.2
	3	Annual Cash Inflows	$                     35,030	0.751	$           26,318.56	0.864	$              30,260.2
	4	Annual Cash Inflows	$                     35,030	0.683	$           23,925.96	0.823	$              28,819.3
	5	Annual Cash Inflows	$                     35,030	0.621	$           21,750.87	0.784	$              27,446.9
		Present Value Of Cash Flow			$          -18,848.74		$                    21.57
		Therefore IRR by interpolation method
			= 5% + (21.57/(201.57+18668.74)*5
			=5%