Question

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.
%

Answer 1

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%