Question

Zachary Manufacturing Company has an opportunity to purchase some technologically advanced equipment that will reduce the company’s cash outflow for operating expenses by $1,287,000 per year. The cost of the equipment is $9,187,846.67. Zachary expects it to have a 11-year useful life and a zero salvage value. The company has established an investment opportunity hurdle rate of 15 percent and uses the straight-line method for depreciation. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required

a.Calculate the internal rate of return of the investment opportunity. (Do not round intermediate calculations.)

b. Indicate whether the investment opportunity should be accepted.

a.	Internal Rate of Return	%
b.	Should the investment opportunity be accepted?

Answer 1

(a) IRR is the discount rate at which NPV of the project is equal to zero

I.e PV of cash inflows - PV of cash outflows(Initial Investment) = 0

Present value annuity factor(11years,IRR) x  $1,287,000 - $9,187,846.67 = 0

Present value annuity factor(11years,IRR) = $9,187,846.67 /  $1,287,000

Present value annuity factor(11years,IRR) = 7.138964

From PVAF table at row 11 (at 11years) we find the factor 7.138964 under the rate of return column marked 8%.

Hence IRR is 8%.

(b) Since IRR (8%) is less than the hurdle rate(15%), the investment opportunity should not be accepted