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 $1) (Use appropriate factor(s) from the tables
provided.)
Required
Compute the net present value of each project. Which project should be adopted based on the net present value approach?
Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach?
a) Computation Of NPV
Project A | Project B | |||||
Particular | Period | PV Factor (8%) | Amount ($) | 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
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