Question

3. 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 $12,500. The cost of capital that applies to both investments is 11%. The life cycle 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 $6,200 per year and those for the gas-powered truck will be $3,500 per year. Annual net cash flows include depreciation expenses. Calculate the NPV and IRR for each type of truck and decide which to recommend.

Answer 1

Gas powered
Discount rate	0.11
Year	0	1	2	3	4	5	6
Cash flow stream	-12500	3500	3500	3500	3500	3500	3500
Discounting factor	1	1.11	1.2321	1.367631	1.5180704	1.685058	1.870415
Discounted cash flows project	-12500	3153.153	2840.678516	2559.17	2305.5584	2077.08	1871.243
NPV = Sum of discounted cash flows
NPV Gas powered =	2306.88
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
electric powered
Discount rate	0.11
Year	0	1	2	3	4	5	6
Cash flow stream	-22000	6200	6200	6200	6200	6200	6200
Discounting factor	1	1.11	1.2321	1.367631	1.5180704	1.685058	1.870415
Discounted cash flows project	-22000	5585.586	5032.059086	4533.387	4084.132	3679.398	3314.773
NPV = Sum of discounted cash flows
NPV electric powered =	4229.33
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Gas powered
IRR is the rate at which NPV =0
IRR	0.171906124
Year	0	1	2	3	4	5	6
Cash flow stream	-12500	3500	3500	3500	3500	3500	3500
Discounting factor	1	1.171906	1.373363965	1.609454	1.8861286	2.210366	2.590341
Discounted cash flows project	-1250000.00%	2986.587	2548.486847	2174.651	1855.6529	1583.448	1351.173
NPV = Sum of discounted cash flows
NPV Gas powered =	4.07904E-06
Where
Discounting factor =	(1 + IRR)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	17.19%
electric powered
IRR is the rate at which NPV =0
IRR	0.174402765
Year	0	1	2	3	4	5	6
Cash flow stream	-22000	6200	6200	6200	6200	6200	6200
Discounting factor	1	1.174403	1.379221854	1.619762	1.9022529	2.234011	2.623629
Discounted cash flows project	-22000	5279.279	4495.2884	3827.723	3259.2932	2775.277	2363.139
NPV = Sum of discounted cash flows
NPV electric powered =	1.00971E-05
Where
Discounting factor =	(1 + IRR)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	17.44%

Choose Electric as it has higher NPV and IRR