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#1 Net Present Value Method, Internal Rate of Return Method, and Analysis The management of Quest...

#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.

Solutions

Expert Solution

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%.


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