Question

Henrie’s Drapery Service is investigating the purchase of a new machine for cleaning and blocking drapes. The machine would cost $137,320, including freight and installation. Henrie’s estimated the new machine would increase the company’s cash inflows, net of expenses, by $40,000 per year. The machine would have a five-year useful life and no salvage value.

Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using table.

Required:

1. What is the machine’s internal rate of return? (Round your answer to whole decimal place i.e. 0.123 should be considered as 12%.)

2. Using a discount rate of 14%, what is the machine’s net present value?

3. Suppose the new machine would increase the company’s annual cash inflows, net of expenses, by only $38,090 per year. Under these conditions, what is the internal rate of return? (Round your answer to whole decimal place i.e. 0.123 should be considered as 12%.)

Answer 1

1
Investment cost	137320
Divide by Annual cash flows	40000
PV factor for Internal rate of return	3.433
The PV factor 3.433 for 5 years is closest to 14%
Internal rate of return = 14%
2
Present value of annual cash flows	137320	=40000*3.433
Less: Investment cost	137320
Net present value	0
3
Investment cost	137320
Divide by Annual cash flows	38090
PV factor for Internal rate of return	3.605
The PV factor 3.605 for 5 years is closest to 12%
Internal rate of return = 12%