Question

Internal Rate of Return

Manzer Enterprises is considering two independent investments:

A new automated materials handling system that costs $900,000 and will produce net cash inflows of $300,000 at the end of each year for the next four years.

A computer-aided manufacturing system that costs $775,000 and will produce labor savings of $400,000 and $500,000 at the end of the first year and second year, respectively.

Manzer has a cost of capital of 8 percent.

The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems.

Required:

1. Calculate the IRR for the first investment. Enter your answers as whole percentage values (for example, 16% should be entered as "16" in the answer box).

Between______?______ % and_______?______ %.

Determine if it is acceptable or not.

Acceptable

2. Calculate the IRR of the second investment. Use 12 percent as the first guess. Enter your answers as whole percentage values (for example, 16% should be entered as "16" in the answer box).

Between _____?_____% and____?______ %.

Answer 1

Solution 1:

At IRR PV of cash inflows is equal to PV of cash outflows therefore

$300,000 * Cumulative PV factor at IRR for 4 periods = $900,000

Cumulative PV factor at IRR for 4 periods =3

This PV Factor fall between at 12% and 13%

Hence IRR falls between 12% and 13%

Solution 2:

Lets calculate present value of cash inflow at 12%

($400,000 * 0.892857) + ($500,000 * 0.797194) = $755,740

Lets calculate present value of cash inflows at 11%

($400,000 * 0.900901) + ($500,000 * 0.811622) = $766,172

Lets calculate present value of cash inflows at 10%

($400,000 * 0.909091) + ($500,000 * 0.826446) = $776,860

As initial investment is $775,000, therefore IRR lies between 10% and 11%