Question

Dwight Donovan, the president of Benson 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 $118,000 and for Project B are $45,000. The annual expected cash inflows are $45,582 for Project A and $16,082 for Project B. Both investments are expected to provide cash flow benefits for the next four years. Benson Enterprises’ desired rate of return is 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required

1. Compute the net present value of each project. Which project should be adopted based on the net present value approach?

2. 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

a) Computation Of NPV

			Project A		Project B
Particular	Period	PV Factor (8%)	Amount ($)	Present value	Amount ($)	Present value
Cash Outflows :
Initial Investment	0	1	118000	118000	45000	45000
PV of cash outflow (a)				118000		45000
Cash inflows :
Annual cash inflows	1 - 4	3.3121	45582	150972	16082	53265
PV of cash inflows (b)				150972		53265
Net Present value ( B - A)				32972		8265

Based on NPV project A should be selected.

b) Computation Of IRR

Period	Project A		Project B
	Cash Flow	IRR	Cash Flow	IRR
0	-118000		-45000
1	45582		16082
2	45582	20%	16082	16%
3	45582		16082
4	45582		16082

Project A should be selected base on IRR