Question

Dwight Donovan, the president of Munoz 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 three 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 $103,000 and for Project B are $40,000. The annual expected cash inflows are $40,691 for Project A and $17,229 for Project B. Both investments are expected to provide cash flow benefits for the next three years. Munoz Enterprises’ cost of capital is 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required

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

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

Answer 1

Req a;
NPV at 8%
Project-A
Annual cash innflows			40,691
Annuity at 8% for 3 years			2.577
Present value of inflows			104,861
Less: Initial investment			103,000
Net present value			1,861
project-B:
Annual cash innflows			17229
Annuity at 8% for 3 years			2.577
Present value of inflows			44399.13
Less: Initial investment			40000
Net present value			4399
Rreq b:
IRR
Project-A:
Annual cash innflows			40,691
Annuity at 9% for 3 years			2.531
Present value of inflows			102,989
Less: Initial investment			103,000
Net present value			11
IRR of Project A: 9%
project-B:
Annual cash innflows			17229
Annuity at 14% for 3 years			2.322
Present value of inflows			40005.74
Less: Initial investment			40000
Net present value			5.74
IRR of Project-B: 14%