Question

Net Present Value Method, Internal Rate of Return Method, and Analysis for a Service Company

The management of Advanced Alternative Power Inc. is considering two capital investment projects. The estimated net cash flows from each project are as follows:

Year	Wind Turbines		Biofuel Equipment
1	$180,000		$360,000
2	180,000		360,000
3	180,000		360,000
4	180,000		360,000

The wind turbines require an investment of $466,020, while the biofuel equipment requires an investment of $1,027,800. No residual value is expected from either project.

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	3.353	2.991
6	4.917	4.355	4.111	3.785	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

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.

	Wind Turbines	Biofuel Equipment
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
Wind Turbines
Biofuel Equipment

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.

	Wind Turbines		Biofuel Equipment
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 wind turbines  is/are a better financial opportunity compared to the biofuel equipment , although both investments meet the minimum return criterion of 10%.

Answer 1

Answer to Requirement 1a:

Wind Turbines:

Present value of annual net cash flows = $180,000 * PVA of $1 (10%, 4)
Present value of annual net cash flows = $180,000 * 3.170
Present value of annual net cash flows = $570,600

Net present value = Present value of annual net cash flows - Amount to be invested
Net present value = $570,600 - $466,020
Net present value = $104,580

Biofuel Equipment:

Present value of annual net cash flows = $360,000 * PVA of $1 (10%, 4)
Present value of annual net cash flows = $360,000 * 3.170
Present value of annual net cash flows = $1,141,200

Net present value = Present value of annual net cash flows - Amount to be invested
Net present value = $1,141,200 - $1,027,800
Net present value = $113,400

Answer to Requirement 1b:

Wind Turbines:

Profitability value index = Present value of annual net cash flows / Amount to be invested
Profitability value index = $570,600 / $466,020
Profitability value index = 1.22

Biofuel Equipment:

Profitability value index = Present value of annual net cash flows / Amount to be invested
Profitability value index = $1,141,200 / $1,027,800
Profitability value index = 1.11

Answer to Requirement 2:

Wind Turbines:

Present value factor for an annuity of $1 = Initial investment / Annual net cash flows
Present value factor for an annuity of $1 = $466,020 / $180,000
Present value factor for an annuity of $1 = 2.589

Using table values, Internal rate of return is 20%

Biofuel Equipment:

Present value factor for an annuity of $1 = Initial investment / Annual net cash flows
Present value factor for an annuity of $1 = $1,027,800 / $360,000
Present value factor for an annuity of $1 = 2.855

Using table values, Internal rate of return is 15%

Answer to Requirement 3:

The net present value, present value index, and internal rate of return all indicate that the wind turbines is/are a better financial opportunity compared to the biofuel equipment, although both investments meet the minimum return criterion of 10%.