Question

Carr Company has to choose between two capital investment proposals (Important: It can only fund one of them). Estimates regarding each project are provided below:

                                                Project Soup            Project Nuts

Initial investment                            $400,000                 $600,000

Annual net income                             30,000                    46,000

Net annual cash inflow                     110,000                   146,000

Estimated useful life                         5 years                  6 years

Salvage value                                     -0-                         -0-

The company requires a 10% rate of return on all new investments.

                     Present Value of an Annuity of 1              

Periods              9%           10%             11%            12%

      5              3.890          3.791          3.696          3.605

      6              4.486          4.355          4.231          4.111

The internal rate of return for Project Soup is

	a.	greater than the discount rate of 10%
	b.	less than the discount rate of 10%
	c.	equal to the discount rate of 10%
	d.	none of the above. __________________________________________ Which project should be funded? a. Project Soup. b. Neither Project. c. Project Nuts. d. Insufficient information to make a determination.

Answer 1

		Project Soup	Project Nuts
	Initial investment	400000	600000
	Net annual cash flow	110000	146000
	Initial investment/Net annual cash flow	3.636	4.110
	Life in years	5	6
	ANSWERS:
1)	The internal rate of return for Project Soup is:
	a. greater than the discount rate of 10%.
	Explanation:
	The interest rate factor for IRR of Project Soup is
	3.636 (400000/110000). It falls between the
	interest rate factors for 11% and 12%.
	The exact value of IRR = 11+(3.696-3.636)/(3.696-3.605) =		11.66
	The internal rate of return of Project Nuts would
	be 12% as the interest rate factor for its IRR is
	very close to the interest rate factor for 12%.
	Going by the IRR Project Nuts with the higher
	IRR should be funded.
2)	As the projects have unequal lives the Equivalent annual worth should
	be used:
	Initial investment	400000	600000
	PVIFA for 10%	3.791	4.355
	AW of initial investment (initial investment/PVIFA(10,n)	-105513	-137773
	Net annual cash flow	110000	146000
	Equivalent annual worth	4487	8227
	Which project should be funded?
	c. Project Nuts, having higher equivalent AW.