In: Finance
#1 Net Present Value Method, Internal Rate of Return Method, and Analysis
The management of Quest Media Inc. is considering two capital investment projects. The estimated net cash flows from each project are as follows:
Year | Radio Station | TV Station | ||
1 | $430,000 | $770,000 | ||
2 | 430,000 | 770,000 | ||
3 | 430,000 | 770,000 | ||
4 | 430,000 | 770,000 |
Present Value of an Annuity of $1 at Compound Interest | |||||
Year | 6% | 10% | 12% | 15% | 20% |
1 | 0.943 | 0.909 | 0.893 | 0.870 | 0.833 |
2 | 1.833 | 1.736 | 1.690 | 1.626 | 1.528 |
3 | 2.673 | 2.487 | 2.402 | 2.283 | 2.106 |
4 | 3.465 | 3.170 | 3.037 | 2.855 | 2.589 |
5 | 4.212 | 3.791 | 3.605 | 3.352 | 2.991 |
6 | 4.917 | 4.355 | 4.111 | 3.784 | 3.326 |
7 | 5.582 | 4.868 | 4.564 | 4.160 | 3.605 |
8 | 6.210 | 5.335 | 4.968 | 4.487 | 3.837 |
9 | 6.802 | 5.759 | 5.328 | 4.772 | 4.031 |
10 | 7.360 | 6.145 | 5.650 | 5.019 | 4.192 |
The radio station requires an investment of $1,113,270, while the TV station requires an investment of $2,198,350. No residual value is expected from either project.
Required:
1a. Compute the net present value for each project. Use a rate of 10% and the present value of an annuity of $1 in the table above. If required, use the minus sign to indicate a negative net present value. If required, round to the nearest whole dollar.
Radio Station | TV Station | |
Present value of annual net cash flows | $ | $ |
Less amount to be invested | $ | $ |
Net present value | $ | $ |
1b. Compute a present value index for each project. If required, round your answers to two decimal places.
Present Value Index | |
Radio Station | |
TV Station |
2. Determine the internal rate of return for each project by (a) computing a present value factor for an annuity of $1 and (b) using the present value of an annuity of $1 in the table above. If required, round your present value factor answers to three decimal places and internal rate of return to the nearest whole percent.
Radio Station | TV Station | |||
Present value factor for an annuity of $1 | ||||
Internal rate of return | % | % |
3. The net present value, present value index, and internal rate of return all indicate that the is a better financial opportunity compared to the , although both investments meet the minimum return criterion of 10%.
#2 Average Rate of Return Method, Net Present Value Method, and analysis for a Service Company
The capital investment committee of Ellis Transport and Storage Inc. is considering two investment projects. The estimated income from operations and net cash flows from each investment are as follows:
Warehouse | Tracking Technology | |||||||
Year | Income from Operations | Net Cash Flow | Income from Operations | Net Cash Flow | ||||
1 | $ 61,400 | $135,000 | $ 34,400 | $108,000 | ||||
2 | 51,400 | 125,000 | 34,400 | 108,000 | ||||
3 | 36,400 | 110,000 | 34,400 | 108,000 | ||||
4 | 26,400 | 100,000 | 34,400 | 108,000 | ||||
5 | (3,600) | 70,000 | 34,400 | 108,000 | ||||
Total | $172,000 | $540,000 | $172,000 | $540,000 |
Each project requires an investment of $368,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 15% for purposes of the net present value analysis.
Present Value of $1 at Compound Interest | |||||
Year | 6% | 10% | 12% | 15% | 20% |
1 | 0.943 | 0.909 | 0.893 | 0.870 | 0.833 |
2 | 0.890 | 0.826 | 0.797 | 0.756 | 0.694 |
3 | 0.840 | 0.751 | 0.712 | 0.658 | 0.579 |
4 | 0.792 | 0.683 | 0.636 | 0.572 | 0.482 |
5 | 0.747 | 0.621 | 0.567 | 0.497 | 0.402 |
6 | 0.705 | 0.564 | 0.507 | 0.432 | 0.335 |
7 | 0.665 | 0.513 | 0.452 | 0.376 | 0.279 |
8 | 0.627 | 0.467 | 0.404 | 0.327 | 0.233 |
9 | 0.592 | 0.424 | 0.361 | 0.284 | 0.194 |
10 | 0.558 | 0.386 | 0.322 | 0.247 | 0.162 |
Required:
1a. Compute the average rate of return for each investment. If required, round your answer to one decimal place.
Average Rate of Return | |
Warehouse | % |
Tracking Technology | % |
1b. Compute the net present value for each investment. Use the present value of $1 table above. If required, use the minus sign to indicate a negative net present value. If required, round to the nearest dollar.
Warehouse | Tracking Technology | |
Present value of net cash flow total | $ | $ |
Amount to be invested | $ | $ |
Net present value | $ | $ |
2. The net present value exceeds the selected rate established for discounted cash flows (15%), while the does not. Thus, considering only quantitative factors, the investment should be selected.
Answer to Question 1:
Requirement 1a:
Radio Station:
Present Value of Annual Net Cash Flows = $430,000 * PVA of $1
(10%, 4)
Present Value of Annual Net Cash Flows = $430,000 * 3.170
Present Value of Annual Net Cash Flows = $1,363,100
Net Present Value = Present Value of Annual Net Cash Flows -
Amount to be Invested
Net Present Value = $1,363,100 - $1,113,270
Net Present Value = $249,830
TV Station:
Present Value of Annual Net Cash Flows = $770,000 * PVA of $1
(10%, 4)
Present Value of Annual Net Cash Flows = $770,000 * 3.170
Present Value of Annual Net Cash Flows = $2,440,900
Net Present Value = Present Value of Annual Net Cash Flows -
Amount to be Invested
Net Present Value = $2,440,900 - $2,198,350
Net Present Value = $242,550
Requirement 1b:
Radio Station:
Present Value Index = Net Present Value / Amount to be
Invested
Present Value Index = $249,830 / $1,113,270
Present Value Index = 0.22
TV Station:
Present Value Index = Net Present Value / Amount to be
Invested
Present Value Index = $242,550 / $2,198,350
Present Value Index = 0.11
Requirement 2:
Radio Station:
Present Value Factor for an Annuity of $1 = Amount to be
Invested / Annual Cash Flows
Present Value Factor for an Annuity of $1 = $1,113,270 /
$430,000
Present Value Factor for an Annuity of $1 = 2.589
Using table values, IRR is 20%
TV Station:
Present Value Factor for an Annuity of $1 = Amount to be
Invested / Annual Cash Flows
Present Value Factor for an Annuity of $1 = $2,198,350 /
$770,000
Present Value Factor for an Annuity of $1 = 2.855
Using table values, IRR is 15%
The net present value, present value index, and internal rate of return all indicate that the Radio Station is a better financial opportunity compared to the TV Station, although both investments meet the minimum return criterion of 10%.