Question

Home Security Systems is analyzing the purchase of manufacturing equipment that will cost $70,000. The annual cash inflows for the next three years will be:

Year	Cash Flow
1		$	35,000
2			33,000
3			28,000

Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the financial calculator method.

a. Determine the internal rate of return. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
  

b. With a cost of capital of 18 percent, should the equipment be purchased?

	Yes
	No

Answer 1

a)

IRR is the rate of return that makes NPV equal to 0.

NPV = -70,000 + 35,000 / (1 + R)¹ + 33,000 / (1 + R)² + 28,000 / (1 + R)³

Using trial and error method, i.e., after trying various values for R, lets try R as 18.37%

NPV = -70,000 + 35,000 / (1 + 0.1837)¹ + 33,000 / (1 + 0.1837)² + 28,000 / (1 + 0.1837)³

NPV = 0

Therrefore, IRR is 18.37%

You can also find the exact answer using a financial calculator:

CF0 -70000

CF1 35000 F01 1

CF2 33000 F01 1

CF3 28000 F01 1

CPT IRR

b)

YES

Equipment should be purchased as the IRR is greater than cost of capital of 18%