Question

Elgin Restaurant Supplies is analyzing the purchase of manufacturing equipment that will cost $28,000. The annual cash inflows are as follows. Use Appendix D. Year 1 2 3 Cash Flow $15,000 13,500 10,500 a. Determine the IRR using interpolation. (Round the intermediate calculations to the nearest whole dollar. Round the final answer to 2 decimal places.) IRR % b. With a cost of capital of 18 percent, should the machine be purchased? Yes NI-

Answer 1

ANSWER: (ALL AMOUNT IN $)

A. Calculation of IRR

In IRR method, present value of cash out flow to be present value of cash inflow

Let pv factor be 18

Year	Cash inflow	PV factor@18%	Present value
1	15000	0.8475	12173
2	13500	0.7182	9696
3	10500	0.6086	6390
Total	39000		28799

from pv factor 18% present value of cash inflow is not match with present value of cash outflow

Let pv factor be 20%

Year	Cash inflow	PV factor@20%	present value
1	15000	0.8333	12500
2	13500	0.6944	9374
3	10500	0.5787	6076
Total	39000		27950

from pv factor 20%present value of cash outflow is also not matched with present value of cash inflow

Now we can use interpolation method

= 18+{(28799-28000)/(28799-27950)}*(20-18)

= 18+(799/849)*2

= 19.88%

B. With a cost of capital of 18% Present value of Cash inflow is $28799 which is more than cash outflow, so we should purchase the machine. Answer Yes

C. Computation of PI with cost of capital of 18%

Profitable Index = Present value of cash inflow / Present value of cash outflow

= 28799 / 28000

= 1.029(approx)