Question

Dwight Donovan, the president of Campbell Enterprises, is considering two investment opportunities. Because of limited resources, he will be able to invest in only one of them. Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of four years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment. Initial cash expenditures for Project A are $113,000 and for Project B are $48,000. The annual expected cash inflows are $34,880 for Project A and $17,154 for Project B. Both investments are expected to provide cash flow benefits for the next four years. Campbell Enterprises’ cost of capital is 6 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required Compute the net present value of each project. Which project should be adopted based on the net present value approach? Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach?

Answer 1

Net present value = Present value of cash inflows - Present value of cash outflows

Project A:

Present value of cash inflows = Annual cash inflows x PVIFA6%,4

= $34,880 x 3.46510 = $120,863

Present value of cash outflows = Initial investment = $113,000

Net present value = $120,863 - $113,000 = $7863

Project B:

Present value of cash inflows = Annual cash inflows x PVIFA8%,4

= $17,154 x 3.46510 = $59,440

Present value of cash outflows = Initial investment = $48,000

Net present value = $59,440 -$48,000=$11,440

Based on the net present value approach, Project B should be accepted.

Internal Rate of Return

Project A=9%

Project B-16%

Project A=9%

IRR = R1 + ((NPV1 x (R2 - R1)) / (NPV1 - NPV2))

or

-113,000 + $34,880 /(1 + R)¹+ $34,880 /(1 + R)²+ $34,880 /(1 + R)³+ $34,880 /(1 + R)⁴

^=9%

Project B-16%

-48,000 + $17,154/(1 + R)¹+ $17,154/(1 + R)²+ $17,154/(1 + R)³+ $17,154/(1 + R)⁴