Question

Welch Corporation is planning an investment with the following characteristics (Ignore income taxes.):

Useful life		6	years
Yearly net cash inflow	$	60,000
Salvage value	$	0
Internal rate of return		16	%
Required rate of return		12	%

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using the tables provided.

The initial cost of the equipment is closest to:

A)Cannot be determined from the given information.

B) $221,100

C) $231,450

D) $300,100

Answer 1

• The answer can be calculated using the “Internal rate of Return”
• Conceptually, the NPV calculated using the Internal rate of Return is ALWAYS $ 0
• NPV = Present values of annual cash flows – Initial Investment.

We know that NPV = $ 0

Lets calculate Present Values using 16% IRR as discounting rate.

You have not provided Exhibits, but the Present Value Annuity [Exhibit 13B-2] for 16% in 6^th period will be 3.685

• Present value of annual cash flows = 3.685 x $ 60000 = $ 221,100
• Hence, Initial Investment = also $ 221,100
• Correct Answer = Option ‘B’ $ 221,100