Question

Big, Steve's makers of swizzle sticks, is considering the purchase of a new plastic stamping machine. This investment requires an initial outlay of $95,000 and will generate net cash flow of $17,000 per year for 8 years. a. What is the project's NPV using a discount rate of 11 percent? Should the project be accepted? Why or Why not? b. What is the project;s NPV using a discount rate of 16 percent? Should the project be accepted? Why or Why not? c. What is this project's internal rate of return? Should the project be accepted? Why or Why not?

Answer 1

Initial Investment = $95,000
Annual Cash Flow = $17,000
Life of Project = 8 years

Answer a.

Discount Rate = 11%

NPV = -$95,000 + $17,000/1.11 + $17,000/1.11^2 + … + $17,000/1.11^7 + $17,000/1.11^8
NPV = -$95,000 + $17,000 * (1 - (1/1.11)^8) / 0.11
NPV = -$95,000 + $87,484.09
NPV = -$7,515.91

NPV of the project is negative, so, you should not accept this project.

Answer b.

Discount Rate = 16%

NPV = -$95,000 + $17,000/1.16 + $17,000/1.16^2 + … + $17,000/1.16^7 + $17,000/1.16^8
NPV = -$95,000 + $17,000 * (1 - (1/1.16)^8) / 0.16
NPV = -$95,000 + $73,841.05
NPV = -$21,158.95

NPV of the project is negative, so, you should not accept this project.

Answer c.

Let IRR be i%

NPV = -$95,000 + $17,000/(1+i) + $17,000/(1+i)^2 + … + $17,000/(1+i)^7 + $17,000/(1+i)^8
0 = -$95,000 + $17,000/(1+i) + $17,000/(1+i)^2 + … + $17,000/(1+i)^7 + $17,000/(1+i)^8

Using financial calculator, i = 8.74%

IRR = 8.74%

This project should not be accepted as its NPV is negative.