Question

Baxwell tire company is thinking about buying a new machine that will increase the speed of manufacturing and save money. The net cost of the machine is $66,000. The annual cash flows are projected as follows:

Year Cash Flow

1 $21,000

2 $ 29,000

3 $ 36,000

4 $ 16,000

5 $ 8,000

A. If the cost of capital is 10%, what is the net present value?

B. What is the internal rate return?

C. Should the project be accepted? Why?

Answer 1

NPV is basically the difference between the sum of present value of all cash inflows which a project generates over the years andthe initial investment (cash outflow) of a particular project.

Year 0	Year 1	Year 2	Year3	Year 4	Year 5
-66000	21000	29000	36000	16000	8000

Cost of Capital

10%

Present value of Cash Flow

19090.91

17355.37

15777.61

14343.28

13039.35

Internal Rate of Return (IRR) is the rate which makesNPV=0.

Net Present Value (NPV) = 79606.52-66000 =$13,606.52

IRR = 23%

Yes, the project should be accepted because it has apositive NPV and also IRR is greater than the cost ofcapital.