Question

Your firm is considering a new project to improve sales channels. Buying a new truck for $100.000 to deliver more goodsto customers will increase sales $35.000 and cost of goods sold $12.000 per year. The cost of thetruck will be paid in 2 installments. Thefirs installment will take place at thetime of the purchase at year 0, at $60.000. The second installment will be paid at the end of year1, $40.000. The truck will be depreciated straight-lineto $10.000 at the end of year 5. Your company will be able to sell the truck for $8.000 whenthe projectis completed. Your company will be able to reduce workingcapital by $70.000 at the beginning of the project. The tax rate is 30% and discount rate is 10% a) Pleasefind IRR and NPV of the project. b) is there a conflict or agreement withthe NPV andIRR rules ? How do you explainthe situation. c)Would you do the project.? why?

Answer 1

a) Internal rate of return and Net present value of a project have not much differences. The IRR calculates the percentage rate of return at which those same cash flows will result in a NPV of zero.

NPV= Net cash inflow during the period t /(1+r)^t - total initial investment

Here, Net cash inflow during the period= ($35,000 and $12,000 Per year)* 5 years= $175,000+ $60,000 = $235,000

r= Discount rate= 10%

t= Number of time periods= 5

Total initial investment= $60,000

So, NPV= The answers is in negative, which proves that the present value of the costs exceeds the present value of the revenues at the assumed discount rate.

b)There is no conflict or agreement with the NPV and IRR rules. Both are used in the evaluation process for capital expenditure. NPV compares the value of a dollar today to the value of the same dollar in the future, taking inflations and returns into account.

C) No, I wont do the project because NPV is found to be Negative in this case. As revenue is less than costs, there will be no profit, only loss. Hence, it should not be undertaken.