Question

Problem 16-19 Using net present value and internal rate of return to evaluate investment opportunities LO 16-2, 16-3 Dwight Donovan, the president of Finch 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 $119,000 and for Project B are $42,000. The annual expected cash inflows are $30,594 for Project A and $12,234 for Project B. Both investments are expected to provide cash flow benefits for the next five years. Finch Enterprises' cost of capital is 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required b. Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach? Complete this question by entering your answers in the tabs below. Required A Required B Compute the net present value of each project. Which project should be adopted based on the net present value approach? (Round your intermediate calculations and final answers to 2 decimal places.) Net Present Value Project A Project B Which project should be adopted?

Answer 1

		Project A	Project B
	Project Cost	$119,000	$42,000
	Project life	5 years	5 years
	Salvage value	$                                                -	$                                            -
	Annual cash inflows	$30,594	$12,234
(A) Calculation of Net present value
	Cash (Outflow)/Inflow			Discounted cash flow
Year	Project A	Project B	Discounting Factor @ 8%	Project A	Project B
0	$                              (119,000)	$                                    (42,000)	1.000000	$                            (119,000.00)	$    (42,000.00)
1	$                                   30,594	$                                      12,234	0.925926	$                                28,327.78	$      11,327.78
2	$                                   30,594	$                                      12,234	0.857339	$                                26,229.42	$      10,488.68
3	$                                   30,594	$                                      12,234	0.793832	$                                24,286.50	$        9,711.74
4	$                                   30,594	$                                      12,234	0.735030	$                                22,487.50	$        8,992.36
5	$                                   30,594	$                                      12,234	0.680583	$                                20,821.76	$        8,326.25
			Net Present Value	$                                   3,152.97	$        6,846.81
			Net Present Value
	Project A		$                               3,152.97
	Project B		$                               6,846.81
	Project to be adopted:	Project B, because Net present value is comparatively higher.
		High NPV means that the project will reap more benefits in terms of cash inflows to the
		firm net of discounting adjustments.
(B) Calculation of Internal Rate of Return
Project A:
Year	Cash (Outflow)/Inflow	Discounting factor @8%	Discounted cash flow	Discounting factor @10%	Discounted cash flow
0	$                              (119,000)	1.000000	$                        (119,000.00)	1.000000	$ (119,000.00)
1	$                                   30,594	0.925926	$                            28,327.78	0.909091	$      27,812.73
2	$                                   30,594	0.857339	$                            26,229.42	0.826446	$      25,284.30
3	$                                   30,594	0.793832	$                            24,286.50	0.751315	$      22,985.73
4	$                                   30,594	0.735030	$                            22,487.50	0.683013	$      20,896.11
5	$                                   30,594	0.680583	$                            20,821.76	0.620921	$      18,996.47
		Total	$                               3,152.97		$      (3,024.67)
	IRR (Using Interpolation)	8+[3152.97/(3152.97+3024.67)]*(10-8)
		9.02077%(approximately)
Project B:
Year	Cash (Outflow)/Inflow	Discounting factor @12%	Discounted cash flow	Discounting factor @15%	Discounted cash flow
0	$                                 (42,000)	1.000000	$                          (42,000.00)	1.000000	$    (42,000.00)
1	$                                   12,234	0.892857	$                            10,923.21	0.869565	$      10,638.26
2	$                                   12,234	0.797194	$                               9,752.87	0.756144	$        9,250.66
3	$                                   12,234	0.711780	$                               8,707.92	0.657516	$        8,044.05
4	$                                   12,234	0.635518	$                               7,774.93	0.571753	$        6,994.83
5	$                                   12,234	0.567427	$                               6,941.90	0.497177	$        6,082.46
		Total	$                               2,100.83		$          (989.73)
	IRR (Using Interpolation)	12+[2100.83/(2100.83+989.73)]*(15-12)
		14.03927% (approximately)
			Internal Rate of Return
	Project A		9.02077%(approximately)
	Project B		14.03927% (approximately)
	Project to be adopted:	Project B, because Internal Rate of Return is comparatively higher.
		High NPV means that the project will get better return on the investment
		Higher IRR means high rate of cash inflows from project.