Question

Mailings Review View Help Table Design Layout - A --- 2 A-EEE 8- 9.2. AaBbceDdl AaBbccDc AaBbcc 1. AaBbc AaBbceDd AaBbceDdt Aa 1 Normal T YU Body YU H-2 YU O_List YU Small ( 1 No Spac... Hear Styles Paragraph Suggested time: 30 minutes Row Hamilton Inc. is considering investing in new boathouses working with solar energy for energy saving purposes. Assume that the expected annual cash inflows from new boathouses will be $10,000. A $35,000 net initial investment is required and they have five-year useful life and 12% required rate of return. Assume that the investment will occur immediately after management approves the project. a. For making decision on whether to approve or reject the project, compute the Net Present Value (NPV) of this new investment and analyze whether it will be accepted or rejected and why. (10 marks) b. To determine a rate at which NPV will be zero, compute Internal Rate of Return and analyze the result. (10 marks

Answer 1

1)

Year Cash Inflows PVF @ 12% PV of Cash Inflows 1 $10,000 0.89285714 $8,929 2 $10,000 0.79719388 $7,972 3 $10,000 0.71178025 $7,118 4 $10,000 0.63551808 $6,355 5 $10,000 0.56742686 $5,674 Total Present Value of Cash Inflows $36,048 Less: Initial Investment $35,000 Net Present Value $1,048

Row Hamilton Inc Should accept this investment proposal because at required rate of return of 12%, this investment provides positive net present value of $1,048.

2) NPV will be Zero at Implicit Rate of Return. which can be calculated as below;

NPV @ 13% ra = 13% NPVa = $172 Year Cash Inflows PVF @ 13% PV of Cash Inflows 1 $10,000 0.88495575 $8,850 2 $10,000 0.78314668 $7,831 3 $10,000 0.69305016 $6,931 4 $10,000 0.61331873 $6,133 5 $10,000 0.54275994 $5,428 Total Present Value of Cash Inflows $35,172 Less: Initial Investment $35,000 Net Present Value $172 NPV @ 14% rb = 14% NPVb = -$669 Year Cash Inflows PVF @ 14% PV of Cash Inflows 1 $10,000 0.87719298 $8,772 2 $10,000 0.76946753 $7,695 3 $10,000 0.67497152 $6,750 4 $10,000 0.59208028 $5,921 5 $10,000 0.51936866 $5,194 Total Present Value of Cash Inflows $34,331 Less: Initial Investment $35,000 Net Present Value -$669

= 13 + [{172 * (14-13)} / {172 - (-669)}]

IRR = ra + NPVa (rb - ra) (NPVa - NPVb) la = lower discount rate ra= higher discount rate NPV = NPV using the lower discount rate NPVb = NPV using the higher discount rate

= 13 + {172*1}/{841}

= 13 + 0.20452

So, NPV will be zero @ 13.20452%

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