Question

Calculate the Internal Rate of Return of each of the following potential investments and recommend whether or not to include them in the upcoming capital budget given that the firm’s cost of capital is 14.5%.

1. New Software:

• Initial Cost                        $25,000
• Training Cost                    $12,000
• Annual Cost Savings         $10,500
• Useful Life                        6 Years

2. Machine A or Machine B

Note: The key word here is “or”. One or the other machine must be bought. So, the analysis should be based on the incremental cash flows resulting from the more expensive alternative.

• Annual Production in units                                   40,000
• Cost of Machine A                                               $38,000
• Cost of Machine B                                                $32,000
• Unit Cost to Produce on Machine A                    $2.20
• Unit Cost to Produce on Machine B                     $2.22
• Useful Life                                                            12 Years

Answer 1

A] Given details are: -

Cash outflow at T0 - 25,000 + 12,000

Cash inflows from T1 to T6 - 10,500 p.a.

Firm's cost of capital is 14.50%.

B] IRR is the rate of return at which the NPV is '0' (zero).

C] NPV = Present value of all cash inflows (-) Present value of all cash outflows

D] Please make sure that there are 3 images of the hand-written answer.

E] Also, answering the second question of 'Machinery A & B' is against the policy of the company. Kindly ask the same through a separate query (separate question).Happy learning!