Question

You are asked to analyze the following proposal to purchase a new machine and are given the annual cash flows associated with it:

• purchase price $500,000
• the net operating cash flows after tax are estimated to be $100,000 per year for each of the ten years
• the cost of capital is 10%

a. Calculate the internal rate of return on this project.

b. What is the net present value for the project?

c. Calculate the payback period.

d. Answer the following:

(1) Should the project be accepted? Why?

(2) By how much will the total value of the company's stock change if they accept this project?

Answer 1

(d)

(a) IRR is the date at which NPV = 0 1.0 PU of Cash inflows = Initial Tovestment 109,000 X PUAF (8 %, 10) =500,000 wherey PUAE = PU annuite factor Hence, using IRR Celeulator we get, rie, IRR = 15.10% (6) NPV = PU of Cash inflows discounted at Cost of Capitel - Initial Investment = 10.000 PAF (10 %, 10)-500,ooo = $ 174, 456.71 c) lay back levied – Initief Torse flerent Annuel met operating probleme - Soo, ooo 5 years It is the time required to recover initial investment wring annual Cash inflows. 100 000

(1)The project should be accepted because IRR is greater than cost of capital .Also NPV of project is positive.

(2)If they accept this project ,the value of this company will increase by NPV amount which is equal to 114,456.71