Question

Pedro Spier, the president of Spier 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 five 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 $105,000 and for Project B are $32,000. The annual expected cash inflows are $35,110 for Project A and $9,321 for Project B. Both investments are expected to provide cash flow benefits for the next five years. Spier Enterprises’ cost of capital is 8 percent. (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required

a-1.	Compute the net present value of each project. (Round your intermediate calculations and final answers to 2 decimal places.)

           

a-2.	Which project should be adopted based on the net present value approach?
	Project A Project B

b-1.	Compute the approximate internal rate of return of each project.

           

b-2.	Which one should be adopted based on the internal rate of return approach?
	Project B Project A

Answer 1

Req a-1
NPV at 8%
Project A
Year	Cashflows	PVF at 8%	Present value
0	-105000	1	-105000
1	35110	0.925926	32509.26
2	35110	0.857339	30101.17
3	35110	0.793832	27871.45
4	35110	0.73503	25806.9
5	35110	0.680583	23895.28
Net present value			35184
Project B
Year	Cashflows	PVF at 8%	Present value
0	-32000	1	-32000
1	9321	0.925926	8630.556
2	9321	0.857339	7991.255
3	9321	0.793832	7399.31
4	9321	0.73503	6851.213
5	9321	0.680583	6343.716
Net present value			5216
Project A shall be accepted
Req b-1
Project A
Year	Cashflows	PVF at 20%	Present value
0	-105000	1	-105000
1	35110	0.833333	29258.33
2	35110	0.694444	24381.94
3	35110	0.578704	20318.29
4	35110	0.482253	16931.91
5	35110	0.401878	14109.92
NPV			0.39
Therefore, IRR is 20%
Project B
Year	Cashflows	PVF at 14%	Present value
0	-32000	1	-32000
1	9321	0.877193	8176.316
2	9321	0.769468	7172.207
3	9321	0.674972	6291.41
4	9321	0.59208	5518.78
5	9321	0.519369	4841.035
Net present value			-0.25
Therefore, IRR is 14%
Hence, Project A shall be accepted