Question

Dwight Donovan, the president of Zachary Enterprises, is considering two investment opportunities. Because of limited resources, he will be able to invest in only one of them. Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of three years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment. Initial cash expenditures for Project A are $117,000 and for Project B are $43,000. The annual expected cash inflows are $46,221 for Project A and $17,903 for Project B. Both investments are expected to provide cash flow benefits for the next three years. Zachary Enterprises’ cost of capital is 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required

1. Compute the net present value of each project. Which project should be adopted based on the net present value approach?

2. Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach?

Answer 1

ANSWERS

(a)

Project A
Particulars	Amount
Projected Cash inflows(a)	$46,221
Discounting Factor(b)	8%
No of years(c)	3
PV Annuity Factor(d)	2.5770
PV of Cash Inflows {e=(a*d)}	$1,19,115.99
Cash Outflow (f)	$117,000
NPV (e-f)	$2,116

Project B
Particulars	Amount
Projected Cash inflows(a)	$17,903
Discounting Factor(b)	8%
No of years(c)	3
PV Annuity Factor(d)	2.5770
PV of Cash Inflows {e=(a*d)}	46,136.031
Cash Outflow (f)	$43,000
NPV (e-f)	$3136

Conclusion: Since NPV in Project B is higher Project B should be chosen.

(b)

YEAR	Project A	Project B
0	($1,17,000)	($43,000)
1	$46,221	$17,903
2	$46,221	$17,903
3	$46,221	$17,903
Internal rate of return	9%	12%

As IRR of PROJECT B is greater than PROJECT A , PROJECT B

(IRR calculation in ms excel, put cursor in irr column then type, =IRR(drag from zero year to third year) and close bracket ,then enter)