Question

Hosier and Wogan (H&W) is a partnership that owns a small company. It is considering two alternative investment opportunities. The first investment opportunity will have a four-year useful life, will cost $15,971.54, and will generate expected cash inflows of $4,400 per year. The second investment is expected to have a useful life of three years, will cost $6,288.49, and will generate expected cash inflows of $2,800 per year. Assume that H&W has the funds available to accept only one of the opportunities. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required

a.	Calculate the internal rate of return of each investment opportunity.

     

b.	Based on the internal rates of return, which opportunity should H&W select?

Answer 1

Solution-

(a)Calculation of Internal Rate of Return of each Investment Oppertunity

First Investment.

Internal Rate of return = 4%

Present Value Annuity Factor = Cost / cash inflow

                                                = $15,971.54/ $4400

                                                = 3.629

From the PVA Factor, Table IRR corresponding to 3.629 for 4 years = 4%

Second Investment.

Internal Rate of return = 28%(approximately)

Present Value Annuity Factor = Cost / cash inflow

                                                = $6,288.49 / $2800

                                                = 2.246

From the PVA Factor, Table IRR corresponding to 2.246for 4 years = 27.872i.e 28%(approximately)

(b)Which opportunity should H&WSelect

H&Wshould Select Second Investment

H&W should Select Second Investment Since it has a higher Internal Rate of Return (28%) than First Investment (4%)