Question

Section 5

Jean's Juice Company is considering an investment in a new juice machine. The machine will cost $10,000. Jean's Juice uses a corporate hurdle rate (cost of capital) of 18% for all of its projects. If the juice machine project has a positive NPV of $5.00, what does this mean?

Group of answer choices

The project's IRR is probably greater than 18%.

The project should be rejected.

The project earns $5.00 on the investment of $10,000.

The project's payback barely exceeds the minimum requirement for the company.

Harry's Hoagie Sandwich Shop is considering buying a new meat slicing machine to speed up its operations. The company believes that the new machine will increase its cash flows by the following amounts:

Year 1: $5,000; Year 2: $6,500; Year 3: $7,500; Year 4: $8,500

The machine will cost $17,000. Harry's uses a cost of capital of 19% for its investment projects.

Calculate the IRR of this project.

Group of answer choices

20.34%

19.00%

$119.98

26.97%

Eddie's Eclairs is thinking about buying a new convection oven for its bakery. The new oven will increase Eddie's cash flows by the following amounts:

Year 1: $5,000; Year 2: $8,000; Year 3: $10,000; Year 4: 11,000

The oven will cost $13,500.

Eddie's cost of capital is 22% for new projects like this.

Calculate the NPV of this project.

Group of answer choices

$5,454.50

$13,500.00

$7,314.04

Answer 1

Answer to Part 1

Net present value is found by subtracting a project initial investment from the present value of its cash inflows discounted at the firm's cost of capital.

NPV = Present value of cash inflows - Initial investment

As per definition of NPV, the option (C) project earn $ 5 on the investment of $ 10000 seems correct.

Answer to Part 2

IRR is the discount rate that equates the present value of cash inflows with the initial investment associated with a project, thereby causing NPV =0.

Calculation of NPV on 19% discount rate of incremental cash flows -

Year	Cash flows	Dis. @ 19%	Dis. Cash flows
1	5000	0.8403	4201.68
2	6500	0.7062	4590.07
3	7500	0.5934	4450.62
4	8500	0.4987	4238.68
			17481.05
Initial investment			17000.00
		NPV	481.05

NPV comes positive therefore we need to discount these cash flows by higher discounting rate like 25%.

Calculation of NPV on 25% discount rate of incremental cash flows -

Year	Cash flows	Dis. @ 25%	Dis. Cash flows
1	5000	0.8000	4000.00
2	6500	0.6400	4160.00
3	7500	0.5120	3840.00
4	8500	0.4096	3481.60
			15481.60
Initial investment			17000.00
		NPV	-1518.40

NPV comes Negative means IRR rate lies in between these two discounting rates, which will be computed by Interpolation method.

IRR = 19% + (17481.05 - 17000)/(17481.05 - 15481.60)*6%

= 19% + 481.05/1999.45

= 19% + 1.44%

= 20.44% (with rounding off difference)

which comes closest to option A 20.34% so option (A) seems correct.

Answer to Part 3

Calculation of NPV for the oven -

Year	Cash flows	Dis. @ 22%	Dis. Cash flows
1	5000	0.8197	4098.36
2	8000	0.6719	5374.90
3	10000	0.5507	5507.07
4	11000	0.4514	4965.39
			19945.72
Oven Cost			13500.00
		NPV	6445.72

The NPV of this project $ 6445.72, which has not given in option provided by question.

Please check with your answer and let me know.