Question

Merrill Corp. has the following information available about a potential capital investment:   

Initial investment	$	1,100,000
Annual net income	$	110,000
Expected life		8	years
Salvage value	$	120,000
Merrill’s cost of capital		7	%

Assume straight line depreciation method is used.  


Required:
1. Calculate the project’s net present value. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Round the final answer to nearest whole dollar.)

         

2. Without making any calculations, determine whether the internal rate of return (IRR) is more or less than 7 percent.

(circle one)

	Greater than 7 Percent
	Less than 7 Percent

   

3. Calculate the net present value using a 13 percent discount rate. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Round the final answer to nearest whole dollar.)

       

4. Without making any calculations, determine whether the internal rate of return (IRR) is more or less than 13 percent.
(circle one)
    

	More than 13 percent
	Less than 13 percent
	Equal to 13 percent

Answer 1

1)
	Net Present Value				$ 3,58,168
	Working:
	Depreciation Expense			=	(Cost - Salvage Value)/Useful Life
				=	(1100000-120000)/8
				=	$       1,22,500
	Year	Net Income		Depreciation		Salvage Value		Cash flows		Present Value of 1		Present value of cash flows
	0							$ -11,00,000		1.0000		$       -11,00,000
	1	$     1,10,000		$ 1,22,500		0		$     2,32,500		0.9346		$           2,17,290
	2	$     1,10,000		$ 1,22,500		0		$     2,32,500		0.8734		$           2,03,075
	3	$     1,10,000		$ 1,22,500		0		$     2,32,500		0.8163		$           1,89,789
	4	$     1,10,000		$ 1,22,500		0		$     2,32,500		0.7629		$           1,77,373
	5	$     1,10,000		$ 1,22,500		0		$     2,32,500		0.7130		$           1,65,769
	6	$     1,10,000		$ 1,22,500		0		$     2,32,500		0.6663		$           1,54,925
	7	$     1,10,000		$ 1,22,500		0		$     2,32,500		0.6227		$           1,44,789
	8	$     1,10,000		$ 1,22,500		1,20,000		$     3,52,500		0.5820		$           2,05,158
		Net Present Value										$           3,58,168
2)
	Greater than 7 percent
	Working:
	IRR is the rate at which Net Present Value is zero.
	Net Present Value and Discount rate has adverse relation.It means if discount rate is increased net present value decreased and vice versa.
	At present at cost of capital of 7%, Net Present Value is more than zero.So, IRR must be higher than cost of capital to bring Net Present Value zero.
3)
	Net Present Value			$     60,853
	Working:
	Year	Cash flows		Present Value of 1		Present value of cash flows
	0	$ -11,00,000		1.0000		$ -11,00,000
	1	$     2,32,500		0.8850		$     2,05,752
	2	$     2,32,500		0.7831		$     1,82,082
	3	$     2,32,500		0.6931		$     1,61,134
	4	$     2,32,500		0.6133		$     1,42,597
	5	$     2,32,500		0.5428		$     1,26,192
	6	$     2,32,500		0.4803		$     1,11,674
	7	$     2,32,500		0.4251		$         98,827
	8	$     3,52,500		0.3762		$     1,32,596
		Net Present Value				$         60,853
4)
	More than 13 percent
	Working:
	BY giving same reason as given in 2nd part, IRR will be more than 13 percent.