Question

Your factory has been offered a contract to produce a part for a new printer. The contract would last for three​ years, and your cash flows from the contract would be

$4.93

million per year. Your upfront setup costs to be ready to produce the part would be

$7.93

million. Your discount rate for this contract is

7.6%.

a. What is the​ IRR?

b. The NPV is

$4.87

​million, which is positive so the NPV rule says to accept the project. Does the IRR rule agree with the NPV​ rule?

Answer 1

a.Internal rate of return can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$7.93 million. The initial cash flow is indicated by a negative sign since it is a cash outflow.  
• Cash flow for each of the fifteen years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of the project is 39.04%.

b.Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$7.93 million. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 12%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 7.6% discount rate is $4.8677 million.

c.According to the internal rate of return decision rule, the project should be accepted since the internal rate of return of the project is higher than the cost of capital.

According to the net present value decision rule, the project should be accepted since the project generates a positive net present value.

Since both NPV and IRR decision rule says to accept the project, the IRR rule agrees with the NPV rule.