Question

Major Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $114,000. The equipment will have an initial cost of $577,000 and have an 8 year life. The equipment has no salvage value. The hurdle rate is 8%. Ignore income taxes. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor from the PV tables.)

a. What is the net present value? (Negative amounts should be indicated by a minus sign. Round your intermediate and final answer to the nearest dollar amount.)

b. What would the net present value be with a 12% hurdle rate? (Negative amounts should be indicated by a minus sign. Round your intermediate and final answer to the nearest dollar amount.)

c. Based on the NPV calculations, what would be the equipment's internal rate of return? (Round your answer to 2 decimal places.)

Answer 1

a) The net present value with a 8% hurdle rate is calculated below:

The net present value(NPV) = $114,000 * PVIFA (8%,8 Years) - $577,000

= $114,000 * 5.74664 - $577,000

= $655,117 - $577,000

= $78,117

b) The net present value with a 12% hurdle rate is calculated below:

The net present value(NPV) = $114,000 * PVIFA (12%,8 Years) - $577,000

= $114,000 * 4.96764 - $577,000

= $566,311 - $577,000

= - $10,6890

c)Based on the NPV calculations, the equipment's internal rate of return is calculated below:

The equipment's internal rate of return(IRR) calculated by Trial and Error Method:

= 8% + $78,117/ ($78,117 - (- $10,689)) * (12% - 8%)

= 8% + $78,117/$88,806 * 4%

= 8% + 3.5%

  = 11.5%

Based on the NPV calculations, the equipment's internal rate of return is 11.5%