Question

Dwight Donovan, the president of Thornton 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 four 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 $107,000 and for Project B are $50,000. The annual expected cash inflows are $41,333 for Project A and $17,160 for Project B. Both investments are expected to provide cash flow benefits for the next four years. Thornton Enterprises’ cost of capital is 6 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Compute the net present value of each project. Which project should be adopted based on the net present value approach? Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach?

Answer 1

	Project A	Project B
Original Costs(a)	$1,07,000	$50,000
Net Cash Inflows	$41,333	$17,160
PV factor of annuity at 6% for 4 years	3.46511	3.46511
PV of Net Cash Inflows(b)	$1,43,223	$59,461
NPV(b-a)	$36,223	$9,461
IRR	20%	14%
Based on NPV Project A should be selected
Based on IRR Project A should be selected

Answer 2

	Project A	Project B
Original Costs(a)	$1,07,000	$50,000
Net Cash Inflows	$41,333	$17,160
PV factor of annuity at 6% for 4 years	3.46511	3.46511
PV of Net Cash Inflows(b)	$1,43,223	$59,461
NPV(b-a)	$36,223	$9,461
IRR	20%	14%
Based on NPV Project A should be selected
Based on IRR Project A should be selected