Question

Problem 10-09
NPVs and IRRs for Mutually Exclusive Projects

Davis Industries must choose between a gas-powered and an electric-powered forklift truck for moving materials in its factory. Because both forklifts perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered truck will cost more, but it will be less expensive to operate; it will cost $22,000, whereas the gas-powered truck will cost $17,500. The cost of capital that applies to both investments is 12%. The life for both types of truck is estimated to be 6 years, during which time the net cash flows for the electric-powered truck will be $6,290 per year and those for the gas-powered truck will be $5,000 per year. Annual net cash flows include depreciation expenses.

1. Calculate the NPV for each type of truck. Do not round intermediate calculations. Round your answers to the nearest dollar.

   Electric-powered truck	$
   Gas-powered truck	$

2. Calculate the IRR for each type of truck. Do not round intermediate calculations. Round your answers to two decimal places.

   Electric-powered truck	%
   Gas-powered truck	%

   Which type of the truck should the firm purchase?
   -Select-Electric-poweredGas-powered

Answer 1

Answer a.

Cost of Capital = 12%

Electric-powered Truck:

NPV = -$22,000 + $6,290/1.12 + $6,290/1.12^2 + $6,290/1.12^3 + $6,290/1.12^4 + $6,290/1.12^5 + $6,290/1.12^6
NPV = -$22,000 + $6,290 * (1 - (1/1.12)^6) / 0.12
NPV = -$22,000 + $25,861
NPV = $3,861

Gas-powered Truck:

NPV = -$17,500 + $5,000/1.12 + $5,000/1.12^2 + $5,000/1.12^3 + $5,000/1.12^4 + $5,000/1.12^5 + $5,000/1.12^6
NPV = -$17,500 + $5,000 * (1 - (1/1.12)^6) / 0.12
NPV = -$17,500 + $20,557
NPV = $3,057

Answer b.

Electric-powered Truck:

Let IRR be i%

NPV = -$22,000 + $6,290/(1+i) + $6,290/(1+i)^2 + $6,290/(1+i)^3 + $6,290/(1+i)^4 + $6,290/(1+i)^5 + $6,290/(1+i)^6
0 = -$22,000 + $6,290/(1+i) + $6,290/(1+i)^2 + $6,290/(1+i)^3 + $6,290/(1+i)^4 + $6,290/(1+i)^5 + $6,290/(1+i)^6

Using financial calculator, i = 18.00%

IRR = 18.00%

Gas-powered Truck:

Let IRR be i%

NPV = -$17,500 + $5,000/(1+i) + $5,000/(1+i)^2 + $5,000/(1+i)^3 + $5,000/(1+i)^4 + $5,000/(1+i)^5 + $5,000/(1+i)^6
0 = -$17,500 + $5,000/(1+i) + $5,000/(1+i)^2 + $5,000/(1+i)^3 + $5,000/(1+i)^4 + $5,000/(1+i)^5 + $5,000/(1+i)^6

Using financial calculator, i = 17.97%

IRR = 17.97%

From above findings, Electric-powered truck should be purchased.