Question

Dwight Donovan, the president of Vernon 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 $103,000 and for Project B are $49,000. The annual expected cash inflows are $40,691 for Project A and $19,704 for Project B. Both investments are expected to provide cash flow benefits for the next three years. Vernon Enterprises’ desired rate of return is 6 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?

Complete this question by entering your answers in the tabs below.

• Required A
• Required B

A. Compute the net present value of each project. Which project should be adopted based on the net present value approach? (Round your final answers to 2 decimal places.)

	Net Present Value Project A Project B Which project should be adopted?

B.

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

	Internal Rate of Return Project A % Project B % Which project should be adopted?

Answer 1

Ans1.)

Calculation of Net Present Value of both projects:

Project A
Particulars	Amount
Projected Cash inflows(a)	40691
Discounting Factor(b)	6%
No of years(c)	3
PV Annuity Factor(d)	2.6730
PV of Cash Inflows {e=(a*d)}	108,767
Cash Outflow (f)	103,000
NPV (e-f)	5,767

Project B
Particulars	Amount
Projected Cash inflows(a)	19,704
Discounting Factor(b)	6%
No of years(c)	3
PV Annuity Factor(d)	2.6730
PV of Cash Inflows {e=(a*d)}	52,668.79
Cash Outflow (f)	49,000
NPV (e-f)	3,668,79

Conclusion: Since NPV in Project A is higher Project A should be choosen.

Ans 2)

Calculation Of Internal Rate of Return:

Irr can be calculated by a simple formula

Outflow = Inflow

In Project A :
103,000 = 40,691PVAF (r, 3)

By following trail and error method:

Let us assume r = 18%

PV of Cash Inflows will be = 88474

Since PV of cash inflows are higher we have to discount it by higher r

Let us take r= 9%

PV of CAsh Inflows = 103,001.1283

So IRR for project A = 9%

In Project B :
49000 = 19,704 PVAF (r, 3)

By following trail and error method:

Let us take r= 10%

PV of CAsh Inflows = 49,001,8776

So IRR for project B = 10%

Conclusion: BAsed on IRR, Project B should be choosen because it has higher IRR.