Question

Iggy Company is considering three capital expenditure projects. Relevant data for the projects are as follows.

Project		Investment		Annual Income		Life of Project
22A		$244,500		$17,490		6 years
23A		274,400		20,770		9 years
24A		282,900		15,700		7 years

Annual income is constant over the life of the project. Each project is expected to have zero salvage value at the end of the project. Iggy Company uses the straight-line method of depreciation.

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(a)

Determine the internal rate of return for each project. (Round answers 0 decimal places, e.g. 13%. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

Project		Internal Rate of Return
22A		enter percentages rounded to 0 decimal places %
23A		enter percentages rounded to 0 decimal places %
24A		enter percentages rounded to 0 decimal places %

(b)

If Iggy Company’s required rate of return is 11%, which projects are acceptable?

Answer 1

Project 22A:

Annual Depreciation = Initial Investment / Life of Project
Annual Depreciation = $244,500 / 6
Annual Depreciation = $40,750

Annual Net Cash Flow = Annual Income + Annual Depreciation
Annual Net Cash Flow = $17,490 + $40,750
Annual Net Cash Flow = $58,240

IRR Factor = Initial Investment / Annual Net Cash Flow
IRR Factor = $244,500 / $58,240
IRR Factor = 4.19815

Using PVA of $1 table at period of 6 years, IRR is 11%

Project 23A:

Annual Depreciation = Initial Investment / Life of Project
Annual Depreciation = $274,400 / 9
Annual Depreciation = $30,488.89

Annual Net Cash Flow = Annual Income + Annual Depreciation
Annual Net Cash Flow = $20,770 + $30,488.89
Annual Net Cash Flow = $51,258.89

IRR Factor = Initial Investment / Annual Net Cash Flow
IRR Factor = $274,400 / $51,258.89
IRR Factor = 5.35322

Using PVA of $1 table at period of 9 years, IRR is 12%

Project 24A:

Annual Depreciation = Initial Investment / Life of Project
Annual Depreciation = $282,900 / 7
Annual Depreciation = $40,414.29

Annual Net Cash Flow = Annual Income + Annual Depreciation
Annual Net Cash Flow = $15,700 + $40,414.29
Annual Net Cash Flow = $56,114.29

IRR Factor = Initial Investment / Annual Net Cash Flow
IRR Factor = $282,900 / $56,114.29
IRR Factor = 5.04150

Using PVA of $1 table at period of 7 years, IRR is 9%

Based on above calculations, Company should accept Project 23A as its IRR is higher than the required return.