Question

10-13. Dave Hirsh publishes his own manuscripts and is unsure which of two new printers he should purchase. He is a novelist living in Parkman, Illinois. Having slept through most of his Finance 300 course in college, he is unfamiliar with cash flow analysis. He enlists the help of the finance professor at the local university, Dr. Gwen French, to assist him. Together they estimate the following expected initial investment (a negative cash flow) and net positive cash flows for years 1 through 3 for each machine. Dave only needs one printer and estimates it will be worthless after three years of heavy

use. Dave’s required rate of return for this project is 8 percent.

Expected Net Cash Flow
Year	Printer 1	Printer 2
0	$(2,000)	$(2,500)
1	900	1,500
2	1,100	1,300
3	1,300	800

a.  Calculate the payback period for each printer.

b.  Calculate the net present value for each printer.

c.  Calculate the internal rate of return for each printer.

d.  Which printer do you think Dr. French will recommend? Why?

e.  Suppose Dave’s required rate of return were 16 percent. Does the decision about which printer to purchase change?

Answer 1

A. PAY BACK PERIOD : IS THE NUMBER OF YEARS A PERSON RECEIVES HIS INVESTED AMOUNT BACK,

IN PRINTER A , THE PERSON AHS INVESTED $2000

WHICH WILL BE RECOVERED IN 2 YEARS.

1. $ 900 WILL BE RECOVERED

2. 1100 WILL BE RECOVERED.

SO IN TWO YEARS TOTAL OF $2000 WILL BE RECOVERED.

SIMILARLY IN PRINTER B, TOTAL INVESTMENT IS $2500

IN YEAR 1 $1500 WILL BE RECOVERED.

IN 2 YEAR WE NEED A TOTAL OF 1000 TO BE RECOVERED.

SO, 1000/1300 * 12 = 9.23 MONTHS

IN A MONTHS THERE IS A TOTAL OF 30 DAYS,

IN 0.23 MONTHS , THE NUMBER OF DAYS IS 7 DAYS.

SO THE MONEY WILL BE RECOVERED IN 1 YEAR 9 MONTHS AND 7 DAYS.

B. THE NPV OF THE PRINTER A IS :

OUTFLOW IS $2000

THE PRESENT VALUE OF CASH INFLOWS IS :

YEAR 1:$900/1.08 = $833

YEAR 2 : $1100/ 1/08^2 = $943

YEAR 3 : 1300/1.08^3 = $1032

THE PRESENT VALUE OF CASH FLOWS = 2807

-2000 + 2807 = 807.

FOR PRINTER B, NPV IS :

THE PRESENT VALUE OF CASH FLOWS:

1500/1.08 = YEAR 1 = 1388

YEAR 2: 1300/1.08^2 = 1115

YEAR 3: 800/1.08^3 = 635

PRESENT VALUE IS : 3138

THE NPV IS : -2500 + 3138 = 638

C. THE IRR IS THE RATE AT WHICH THE NPV IS ZERO,

SO FOR PRINTER A

-2000 + 900/(1+R) + 1100/(1+R)^2 + 1300/(1+R)^3 = 0

UPON SOLVING THE RATE OF RETURN WE GET,

THE IRR AS 27.81 ( SOLVED WITH THE HELP OF BA 2 PLUS CALCULATOR)

SIMILARLY FOR PRINTER B WE GET,IRR AS 23.25

THE PROJECT WITH THE HIGHER NPV AND IRR SHOULD BE SELECTED ,

SO ON THAT BASIS WE SELECT PRINTER A,

WITH A NPV OF 807 AND IRR OF 27.81.