Question

# Home Security Systems is analyzing the purchase of manufacturing equipment that will cost \$70,000. The annual...

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

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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