Question

Net Present Value Method and Internal Rate of Return Method for a Service Company Buckeye Healthcare Corp. is proposing to spend $186,725 on an eight-year project that has estimated net cash flows of $35,000 for each of the eight years:

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

a. Compute the net present value, using a rate of return of 12%. Use the table of present value of an annuity of $1 presented above. If required, round your answers to the nearest dollar. If required, use the minus sign to indicate a negative net present value.

Present value of annual net cash flows	$
Less amount to be invested	$
Net present value	$

b. Based on the analysis prepared in part (a), is the rate of return (1) more than 12%, (2) 12%, or (3) less than 12%?

c. Determine the internal rate of return by computing a present value factor for an annuity of $1 and using the table of the present value of an annuity of $1 presented above.
%

Answer 1

Reqa: Net present value at 12%

Present value of cash inflows for 8 years ($35,000*4.968 i.e. annuity factor for 8th year @12%): $173,880

Less: Initial investment:                                                                                                                    186,725

Net present value:                                                                                                                            ($12,845)

ReqB: As the NPV is negative at 12% rate, therefore, the rate of return is

(3) less than 12%

ReqC: Internal rate of return

NPV at 10%:

Present value of cash inflows for 8 years ($35,000*5.335 i.e. annuity factor for 8th year @10%): $186725

Less: Initial investment:                                                                                                                    186,725

Net present value:                                                                                                                            Nil

As NPV is nil at 10%, Therefore, the Internal rate of return is 10%