Question

Davis Industries must choose between a gas-powered and an electric-powered forklift truck for moving materials in its factory. Because both forklifts perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered truck will cost more, but it will be less expensive to operate, it will cost $22,000, whereas the gas-powered truck will cost $17,500. The cost of capital that applies to both investments is 15%. The life cycle for both types of truck is estimated to be 6 years, during which time the net cash flows for the electric-powered truck will be $6,590 per year and those for the gas-powered truck will be $5,500 per year. Annual net cash flows include depreciation expenses. Calculate the NPV and IRR for each type of truck and decide which to recommend.

Answer 1

Given Data

Cost of Electric Powered Truck= 22000

Cost of Gas Powered Truck= 17500

Life Cycle= 6 years for both

Cost of Capital =15%

Net Cash flow from Electric Powered Truck= 6950 Per annum

Net Cash flow from Gas Powered Truck= 5500 Per annum

1. Electric powered truck

Year	Description	Cashflow	Present Value Factor @15%	Discounted Cash flow	Present Value Factor @23%	Discounted Cash flow
0	Initial Investment	-22000	1.0000	-22000	1.0000	-22000.00
1	Cash Inflow	6950	0.8696	6043.48	0.8130	5650.41
2	Cash Inflow	6950	0.7561	5255.20	0.6610	4593.83
3	Cash Inflow	6950	0.6575	4569.74	0.5374	3734.82
4	Cash Inflow	6950	0.5718	3973.69	0.4369	3036.44
5	Cash Inflow	6950	0.4972	3455.38	0.3552	2468.65
6	Cash Inflow	6950	0.4323	3004.68	0.2888	2007.03
			NPV	4302.15		-508.83

Computation of IRR

IRR is the rate of return where NPV is 0

If you increase rate of interest by 8%, NPV changes by $ 4811(4302.15+508.83), how much to increase if NPV to change by $4302.15 so that NPV will be 0

(8*4302.15)/4811

7.15%

There fore

NPV= 4302.15

IRR= 22.15%

2. Gas Powered Truck

Year	Description	Cashflow	Present Value Factor @15%	Discounted Cash flow	Present Value Factor @23%	Discounted Cash flow
0	Initial Investment	-17500	1.0000	-17500	1.0000	-17500.00
1	Cash Inflow	5500	0.8696	4782.61	0.8130	4471.54
2	Cash Inflow	5500	0.7561	4158.79	0.6610	3635.40
3	Cash Inflow	5500	0.6575	3616.34	0.5374	2955.61
4	Cash Inflow	5500	0.5718	3144.64	0.4369	2402.94
5	Cash Inflow	5500	0.4972	2734.47	0.3552	1953.61
6	Cash Inflow	5500	0.4323	2377.80	0.2888	1588.30
			NPV	3314.65		-492.60

Computation of IRR

IRR is the rate of return where NPV is 0

If you increase rate of interest by 8%, NPV changes by $ 3807.26(3314.65+492.60), how much to increase if NPV to change by $4302.15 so that NPV will be 0

(8*3314.65)/3807.26

6.97%

There fore

NPV= 3314.65

IRR= 21.97%

Conclusion

Particulars	NPV	IRR
Electric Powered Truck	4302.15	22.15%
Gas Powered Truck	3314.65	21.97%
Conclusion	Electric Powered Truck	Electric Powered Truck

Since both NPV and IRR are suggesting electric powered truck, it is recommended to go for electric powered truck