Question

Dwight Donovan, the president of Solomon 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 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 $115,000 and for Project B are $45,000. The annual expected cash inflows are $35,497 for Project A and $16,082 for Project B. Both investments are expected to provide cash flow benefits for the next four years. Solomon Enterprises’ cost of capital is 8 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?

• Required A
• Required B

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

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

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

Answer 1

Part A: Computation of Net Present Value of both projects:

Year	Cash Flow	Present Value Factor @ 8%	Discounted Cash Flow
Project A	Project B	Project A	Project B
0	$    -1,15,000.00	$        -45,000.00	1.0000	$    -1,15,000.00	$        -45,000.00
1	$          35,497.00	$          16,082.00	0.9259	$          32,867.59	$          14,890.74
2	$          35,497.00	$          16,082.00	0.8573	$          30,432.96	$          13,787.72
3	$          35,497.00	$          16,082.00	0.7938	$          28,178.66	$          12,766.41
4	$          35,497.00	$          16,082.00	0.7350	$          26,091.35	$          11,820.75
NET PRESENT VALUE	$            2,570.57	$            8,265.62

Net Present Value of Project A = $ 2,570.57

Net Present Value of Project B = $ 8,265.52

Since, Net Present Value of Project B is greater than Project A, it is recommended to choose Project B

Part B: Computation of Internal Rate of Return (IRR) of both projects:

Internal Rate of Return is the rate at which Discounted Cash Inflow is equal to Discounted Cash Outflow.

In other words, IRR is the rate at which NPV = 0. The rate of IRR is arrived on a trial and error basis.

IRR of Project A

Year	Cash Flow - Project A	PVF @ 10%	Discounted Cash Flow @ 10%	PVF @ 9%	Discounted Cash Flow @ 9%
0	$ -1,15,000.00	1.0000	$    -1,15,000.00	1.0000	$    -1,15,000.00
1	$       35,497.00	0.9091	$          32,270.00	0.9174	$          32,566.00
2	$       35,497.00	0.8264	$          29,336.00	0.8417	$          29,877.00
3	$       35,497.00	0.7513	$          26,669.00	0.7722	$          27,410.00
4	$       35,497.00	0.6830	$          24,245.00	0.7084	$          25,147.00
			$          -2,480.00		$                          -

Since NPV = 0 at an interest rate of 9%, IRR is 9%

IRR of Project B:

Year	Cash Flow - Project A	PVF @ 15%	Discounted Cash Flow @ 15%	PVF @ 16%	Discounted Cash Flow @ 16%
0	$      -45,000.00	1.0000	$        -45,000.00	1.0000	$        -45,000.00
1	$       16,082.00	0.8696	$          13,984.00	0.8621	$          13,864.00
2	$       16,082.00	0.7561	$          12,160.00	0.7432	$          11,952.00
3	$       16,082.00	0.6575	$          10,574.00	0.6407	$          10,303.00
4	$       16,082.00	0.5718	$            9,195.00	0.5523	$            8,881.00
			$                913.00		$                          -

Since NPV = 0 at an interest rate of 16%, IRR is 16%.

It is recommended to take up Project B since the Internal Rate of Return is higher for this project.