Question

12. The Danforth Tire Company is considering the purchase of a new machine that would increase the speed of manufacturing and save money. The net cost of this machine is $66,000. The annual cash flows have the following projections. Year Cash Flow 1 $21,000 2 $29,000 3 $36,000 4 $16,000 5 $8,000 a. If the cost of capital is 10 percent, what is the net present value? b. What is the internal rate of return (IRR) c. Should the project be accepted? Why? This all information they give me

Answer 1

a. Net Present Value = Present Value of Cash Inflows - Present Value of Cash Outflows

= [ $ 21,000 * 1/(1.1) ^ 1 + $ 29,000* 1/(1.1) ^ 2 + $ 36,000* 1/(1.1) ^ 3 + $ 16,000* 1/(1.1) ^ 4 + $ 8000* 1/(1.1) ^ 5 ] - $ 66,000

= $ 20,000.77

Hence the correct answer is $ 20,000.77

b.

Let the IRR be x.

Now , Present Value of Cash Outflows=Present Value of Cash Inflows

66,000 = 21000/(1.0x) +29000/ (1.0x)^2 +36000/(1.0x)^3+ $ 16000/(1.0x)^4 + $ 8000/(1.0x)^5

Or x= 22.544%

Hence the IRR is 22.54%

c. Since the NPV is positive the project must be accepted.

Hence the correct answer is Accepted.