Question

Exercise 12-5 (Video)

Bruno Corporation is involved in the business of injection molding of plastics. It is considering the purchase of a new computer-aided design and manufacturing machine for $426,000. The company believes that with this new machine it will improve productivity and increase quality, resulting in an increase in net annual cash flows of $103,614 for the next 6 years. Management requires a 10% rate of return on all new investments. Click here to view PV table.

Calculate the internal rate of return on this new machine. (Round answer to 0 decimal places, e.g. 13%. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

Internal rate of return

%

Should the investment be accepted?

The investment

shouldshould not

be accepted.

Answer 1

The internal rate of return (IRR) on this new machine

The Present Value factor for determining IRR = Initial Investment Cost / Net Annual Cash Inflow

= $426,000 / $103,614

= 4.11141

By looking into the Present Value Annuity Factor Table (PVAIF Table), the discount rate (IRR) corresponding to the factor of 4.11141 for 6 Years is closest to 12.00%

“Hence, the internal rate of return (IRR) on this new machine = 12%”

DECISION

YES. The investment should be accepted, since the internal rate of return (IRR) on this new machine (12%) is greater than the required rate of return (10%).