Question

Merrill Corp. has the following information available about a potential capital investment:

Initial investment $ 2,200,000

Annual net income $ 190,000

Expected life 8 years

Salvage value $ 200,000

Merrill’s cost of capital 8 %

Assume straight line depreciation method is used.

Required: 1. Calculate the project’s net present value.

2. Without making any calculations, determine whether the internal rate of return (IRR) is more or less than 8 percent.

3. Calculate the net present value using a 12 percent discount rate.

4. Without making any calculations, determine whether the internal rate of return (IRR) is more or less than 12 percent.

Answer 1

Req. 1)
Net Present Value		=	Present value of inflow - Present value of outflow
		=	[$ 440000 x PVAF(8%, 8 years) + $ 200000 x PVF(8%, 8th year)] - $ 2200000
		=	[($ 440000 x 5.746639) + ($ 200000 x 0.540269)] - $ 2200000
		=	$      4,36,575
Req. 2)	More than 8%
Req. 3)
Net Present Value		=	Present value of inflow - Present value of outflow
		=	[$ 440000 x PVAF(12%%, 8 years) + $ 200000 x PVF(12%, 8th year)] - $ 2200000
		=	[($ 440000 x 4.96764) + ($ 200000 x 0.403883)] - $ 2200000
		=	$          66,538
Req. 4)	More than 12%

Workings:

	Computation of annual cash inflow
	Annual net income			$ 1,90,000.00
Add:	Depreciation			$ 2,50,000.00	[($ 2200000 - $ 200000) / 8 years]
				$ 4,40,000.00

Is this correct?