Question

Dwight Donovan, the president of Vernon Enterprises, is considering two investment opportunities. Because of limited resources, he will be able to invest in only one of them. Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of four years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment. Initial cash expenditures for Project A are $115,000 and for Project B are $49,000. The annual expected cash inflows are $35,497 for Project A and $16,817 for Project B. Both investments are expected to provide cash flow benefits for the next four years. Vernon Enterprises’ desired rate of return is 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required

1. Compute the net present value of each project. Which project should be adopted based on the net present value approach?

2. Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach?

Compute the net present value of each project. Which project should be adopted based on the net present value approach? (Round your final answers to 2 decimal places.)

	Net Present Value
Project A
Project B
Which project should be adopted?

Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach?

	Internal Rate of Return
Project A		%
Project B		%
Which project should be adopted?

Answer 1

a)	NPV	=	Present value of inflows - PV of outflows
	Project A	=	[$ 35497 x PVAF (@ 8%, 4 years)] - $ 115000
		=	($ 35497 x 3.3121) - $ 115000
		=	$ 2570.57
	Project B	=	[$ 16817 x PVAF (@ 8%, 4 years)] - $ 49000
		=	($ 16817 x 3.3121) - $ 49000
		=	$   6,700.04
	Project B shall be adopted as per NPV

b)	IRR
		Year 0	Year 1	Year 2	Year 3	Year 4	IRR
	Project A	$ -1,15,000.00	$ 35,497.00	$ 35,497.00	$ 35,497.00	$ 35,497.00	9%
	Project B	$    -49,000.00	$ 16,817.00	$ 16,817.00	$ 16,817.00	$ 16,817.00	14%
	Project B shall be selected as per IRR