Question

Dwight Donovan, the president of Donovan Enterprises is considering two investment opportunities. Because of limited resources he will be able to only invest in 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 four 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 $400,000 and for Project B are $160,000. The annual expected cash inflows are $126,000 for Project A and $52,800 for Project B. Both investments are expected to provide cash flow benefits for the next four years. Donovan Enterprise desired rate of return is 8 percent.

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

B) Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach? Round your rates to six decimal points.

C)Compare the net present value approach with the internal rate of return approach.Which method is better in the given circumstances? Why?

Pleas use Excel®—showing all work and formulas

Answer 1

Solution A:

Computation of NPV
			Project A	Project B
Particulars	Period	PV Factor (8%)	Amount	Present Value	Amount	Present Value
Cash outflows:
Initial investment	0	1	$400,000	$400,000.00	$160,000	$160,000.00
Present Value of Cash outflows (A)				$400,000.00		$160,000.00
Cash Inflows
Annual cash inflows	1-4	3.31213	$126,000	$417,328.38	$52,800	$174,880.46
Present Value of Cash Inflows (B)				$417,328.38		$174,880.46
Net Present Value (NPV) (B-A)				$17,328.38		$14,880.46

Solution B:

Computation of IRR
Period	Project A	Project B
Cash Flows	IRR	Cash Flows	IRR
0	-$400,000.00	9.93%	-$160,000.00	12.11%
1	$126,000.00	$52,800.00
2	$126,000.00	$52,800.00
3	$126,000.00	$52,800.00
4	$126,000.00	$52,800.00

Solution c:

Based on NPV, project A should be selected.

Based on IRR project B should be selected.