Question

NPV and IRR

Each of the following scenarios is independent. All cash flows are after-tax cash flows.

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

Required:

1. Patz Corporation is considering the purchase of a computer-aided manufacturing system. The cash benefits will be $787,000 per year. The system costs $4,697,000 and will last nine years. Compute the NPV assuming a discount rate of 8 percent.
$

Should the company buy the new system?
Yes

2. Sterling Wetzel has just invested $399,000 in a restaurant specializing in German food. He expects to receive $66,478 per year for the next seven years. His cost of capital is 3.55 percent. Compute the internal rate of return. Round your answers to whole percentage value (for example, 16% should be entered as "16" in the answer box).
%

Did Sterling make a good decision?
Yes

Answer 1

Solution 1:

Computation of NPV
Particulars	Period	PV Factor (13%)	Amount	Present Value
Cash outflows:
Initial investment	0	1	$4,697,000	$4,697,000
Present Value of Cash outflows (A)				$4,697,000
Cash Inflows
Annual Cash inflows	1-9	6.24689	$787,000.00	$4,916,301
Present Value of Cash Inflows (B)				$4,916,301
Net Present Value (NPV) (B-A)				$219,301

As NPV is positive, therefore company should buy the new system.

Solution 2:

Let IRR = i

Now at IRR, present value of cash inflows = Initial investment

$66,478 * cumulative PV Factor at i for 7 periods = $399,000

cumulative PV Factor at i for 7 periods = $399,000 / $66,478 = 6.0019856

Refer PV Factor table, this PV Factors at 7 periods, is falling at i = 4%

Therefore IRR = 4%

As IRR is higher than company cost of capital, therefore Sterling make a good decision of investment.