Question

Net Present Value Method, Internal Rate of Return Method, and Analysis for a Service Company

The management of Advanced Alternative Power Inc. is considering two capital investment projects. The estimated net cash flows from each project are as follows:

Year	Wind Turbines		Biofuel Equipment
1	$200,000		$420,000
2	200,000		420,000
3	200,000		420,000
4	200,000		420,000

The wind turbines require an investment of $571,000, while the biofuel equipment requires an investment of $1,087,380. No residual value is expected from either project.

Present Value of an Annuity of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	1.833	1.736	1.690	1.626	1.528
3	2.673	2.487	2.402	2.283	2.106
4	3.465	3.170	3.037	2.855	2.589
5	4.212	3.791	3.605	3.353	2.991
6	4.917	4.355	4.111	3.785	3.326
7	5.582	4.868	4.564	4.160	3.605
8	6.210	5.335	4.968	4.487	3.837
9	6.802	5.759	5.328	4.772	4.031
10	7.360	6.145	5.650	5.019	4.192

Required:

1a. Compute the net present value for each project. Use a rate of 10% and the present value of an annuity of $1 in the table above. If required, use the minus sign to indicate a negative net present value. If required, round to the nearest whole dollar.

	Wind Turbines	Biofuel Equipment
Present value of annual net cash flows	$	$
Less amount to be invested
Net present value	$	$

1b. Compute a present value index for each project. If required, round your answers to two decimal places.

	Present Value Index
Wind Turbines
Biofuel Equipment

2. Determine the internal rate of return for each project by (a) computing a present value factor for an annuity of $1 and (b) using the present value of an annuity of $1 in the table above. If required, round your present value factor answers to three decimal places and internal rate of return to the nearest whole percent.

	Wind Turbines		Biofuel Equipment
Present value factor for an annuity of $1
Internal rate of return		%		%

3. The net present value, present value index, and internal rate of return all indicate that the   is/are a better financial opportunity compared to the  , although both investments meet the minimum return criterion of 10%.

Answer 1

Solution 1a:

Computation of NPV
			Wind Turbines		Biofuel equipment
Particulars	Period	PV Factor	Amount	Present Value	Amount	Present Value
Cash outflows:
Initial investment	0	1	$571,000.00	$571,000	$1,087,380.00	$1,087,380
Present Value of Cash outflows (A)				$571,000		$1,087,380
Cash Inflows:
Annual cash inflows	1-4	3.17	$200,000.00	$634,000	$420,000.00	$1,331,400
Present Value of Cash Inflows (B)				$634,000		$1,331,400
Net Present Value (NPV) (B-A)				$63,000		$244,020

solution 1b:

Particulars	Initial investment	PV of cash inflows	Present Value Index
wind Turbines	$571,000.00	$634,000.00	1.11
Biofuel equipment	$1,087,380.00	$1,331,400.00	1.22

Solution 2:

Computation of IRR
Particulars	Wind Turbines	Biofuel equipment
Initial investment	$571,000.00	$1,087,380.00
Annual cash inflows	$200,000.00	$420,000.00
Present value factor at IRR	2.855	2.589
IRR	15%	20%

Solution 3:

The net present value, present value index, and internal rate of return all indicate that the Biofuel equipment is/are a better financial opportunity compared to the Wind turbines , although both investments meet the minimum return criterion of 10%.