Question

A company can invest in each of three cheese-making projects: C1, C2 and C3. Each project requires an initial investment of $312,000 and would yield the following annual cash flows. (PV of $1, FV of $1, PVA of $1, and FVA of $1)

Year 1 Year 2 Year 3 Totals ci $ 40,000 136,000 196,000 $372,000 c2 $124,000 124,000 124,000 $372,000 $208,000 88,000 76,000 $372,000 1. Assume that the company requires a 9% return from its investments. Using net present value, determine which projects, if any. should be acquired. 2. Using the answer from part 1, is the internal rate of return higher or lower than 9% for Project C2?

Answer 1

Project C1 Intitial Investment $ 312,000 Chart values are based on 9 % Year Cash inflow X PV Factor = Present Value 1 40,000 0.9174 36,696 136,000 0.8417 = 114,471 196,000 0.7722 = 151,351 302,518 Present value of cash inflows Present value of cash outflows Net Present value Should the company acquire this investment 302,518 (312,000) (9,482) No Project C2 Intitial Investment $ 312,000 Chart values are based on 9 % Year Cash inflow X PV Factor = Present Value 124,000 0.9174 = 113,758 124,000 0.8417 = 104,371 124,000 0.7722 = 95,753 313,881 Present value of cash inflows Present value of cash outflows Net Present value Should the company acquire this investment 313,881 (312,000) 1,881 Yes

Project C3 Intitial Investment $ 312,000 Chart values are based on 9 % Year Cash inflow X PV Factor = Present Value 208,000 0.9174 190,819 88,000 0.8417 = 1 74,070 76,000 0.7722 58,687 323,576 Present value of cash inflows Present value of cash outflows Net Present value Should the company acquire this investment 323,576 (312,000) 11,576 Yes Is the internal rate of return higher or lower than 9% for project C2? Higher Reason: As NPV is in positive at 9 % hence IRR should be greater than 9%