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%

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