Question

# Net Present Value Method and Internal Rate of Return Method for a Service Company Buckeye Healthcare...

Net Present Value Method and Internal Rate of Return Method for a Service Company

Buckeye Healthcare Corp. is proposing to spend \$186,725 on an eight-year project that has estimated net cash flows of \$35,000 for each of the eight years.

 Present Value of an Annuity of \$1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 1.833 1.736 1.690 1.626 1.528 3 2.673 2.487 2.402 2.283 2.106 4 3.465 3.170 3.037 2.855 2.589 5 4.212 3.791 3.605 3.353 2.991 6 4.917 4.355 4.111 3.785 3.326 7 5.582 4.868 4.564 4.160 3.605 8 6.210 5.335 4.968 4.487 3.837 9 6.802 5.759 5.328 4.772 4.031 10 7.360 6.145 5.650 5.019 4.192

a. Compute the net present value, using a rate of return of 12%. Use the table of present value of an annuity of \$1 presented above. If required, round your answers to the nearest dollar. If required, use the minus sign to indicate a negative net present value.

 Present value of annual net cash flows \$ Less amount to be invested Net present value \$

b. Based on the analysis prepared in part (a), is the internal rate of return (1) more than 12%, (2) 12%, or (3) less than 12%?

c. Determine the internal rate of return by computing a present value factor for an annuity of \$1 and using the table of the present value of an annuity of \$1 presented above.
%

Solution a:

 Computation of NPV Particulars Period Amount PV factor at 12% Present Value Cash outflows: Initial investment 0 \$186,725.00 1 \$186,725 Present Value of Cash outflows (A) \$186,725 Cash Inflows Annual cash inflows 1-8 \$35,000.00 4.9680 \$173,880 Present Value of Cash Inflows (B) \$173,880 Net Present Value (NPV) (B-A) -\$12,845

Solution b:

As NPV is negative, therefore internal rate of return is less than 12%.

Solution c:

Present value factor at IRR = Initial investment / Annual cash inflows

= \$186,725 / \$35,000 = 5.335

Refer PV factor table at period 8, this factor falls at IRR = 10%