Question

Dwight Donovan, the president of Donovan Enterprises, is considering two investment opportunities. Because of limited resources, he will be able to invest in only one of them. Project eight 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 AR $400,000 in for project B or $160,000. The annual expected cash inflows or $126,000 for project and $52,800 for project B. Both investments are expected to provide cash flow benefits for the next four years. Donovan Enterprises cost of capital is 8%.

a. compute the net present value of each project. Which project should be adopted based on the net present value approach? Round your computation to two decimal points

b. compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach? Round your rights to six decimal points.

c. compare the net present value approach with the internal rate of return approach. Which method is better in the given circumstances? Why?

Planning for Capital Inve 10. The annual expected cash inflow sent equipment. Initial cash expenditures for Proiect A are $400.000 and for Project B lows are $126,000 for Project A and $52.800 for Project B. ents are expected provide cash flow benefits for the next four years. Donovan sperating the current are $160.000. The Both investments a Enterprises' costa ises' cost of capital is 8 percent. Required Compute the net present value appro 1. Compute the app based on the inte . Compare the ne is better in the give the net present Value of each project. Which project should be adopted based on the net approach? Round your computations to two decimal points. be approximate internal rate of return of each project. Which one should be adopted the internal rate of return approach? Round your rates to six decimal points. the net present value approach with the internal rate of return approach. Which method ter in the given circumstances? Why?

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	$400,000	$400,000.00	$160,000	$160,000.00
Present Value of Cash outflows (A)				$400,000.00		$160,000.00
Cash Inflows
Annual cash inflows	1-4	3.31213	$126,000	$417,328.38	$52,800	$174,880.46
Present Value of Cash Inflows (B)				$417,328.38		$174,880.46
Net Present Value (NPV) (B-A)				$17,328.38		$14,880.46

Solution b:

Computation of IRR
Period	Project A		Project B
	Cash Flows	IRR	Project B	IRR
0	-$400,000.00	10%	-$160,000.00	12%
1	$126,000.00		$52,800.00
2	$126,000.00		$52,800.00
3	$126,000.00		$52,800.00
4	$126,000.00		$52,800.00

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Solution c:

IRR method is better in given circumstances as NPV may be higher due to highest investment size.