Question

Net Present Value Method and Internal Rate of Return Method Buckeye Healthcare Corp. is proposing to spend $93,150 on an eight-year project that has estimated net cash flows of $15,000 for each of the eight years. Present Value of an Annuity of $1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 1.833 1.736 1.690 1.626 1.528 3 2.673 2.487 2.402 2.283 2.106 4 3.465 3.170 3.037 2.855 2.589 5 4.212 3.791 3.605 3.352 2.991 6 4.917 4.355 4.111 3.784 3.326 7 5.582 4.868 4.564 4.160 3.605 8 6.210 5.335 4.968 4.487 3.837 9 6.802 5.759 5.328 4.772 4.031 10 7.360 6.145 5.650 5.019 4.192 a. Compute the net present value, using a rate of return of 10%. Use the table of present value of an annuity of $1 presented above. If required, round to the nearest dollar. Use the minus sign to indicate a negative net present value. Present value of annual net cash flows $ Less amount to be invested $ Net present value $ b. Based on the analysis prepared in part (a), is the rate of return (1) more than 10%, (2) 10%, or (3) less than 10%? c. Determine the internal rate of return by computing a present value factor for an annuity of $1 and using the table of the present value of an annuity of $1 presented above. %

Answer 1

a.)
Present value of annual net cash flows = Annual Cash Inflow * Annuity factor (10%,8Years) = 15000*5.335 = 80025
Less amount to be invested = 93150
Net present value = 80025 - 93150 = - 13,125

b.)
As NPV is negative at 10%, thus the rate of return is less than 10%

c)
For Rate of Return (IRR),
NPV = 0
Present value of annual net cash flows - Less amount to be invested = 0
[15000 * Annuity factor (10%,8Years) ]- 93150 = 0
15000 * Annuity factor (10%,8Years) = 93150
Annuity factor (10%,8Years) = 93150/15000
Annuity factor (10%,8Years) = 6.210

In table at 8% 6.210 is an annuity factor at 6%

Thus IRR =Rate of Return = 6%